Mike McLain

A Reg Z refresher

Specific requirements apply to open-end and preferential employee loans.

July 1, 2018

There are two important issues under Regulation Z that were revised by a Federal Reserve Board final rule in April 2011—floor rates on open-end loans and employee preferential rates.

It’s appropriate to remind credit unions of the specific requirements regarding these issues.

Preferential loan rates for employees

Preferential loan rates are lower rates or annual percentage rates (APR) many credit unions offer to their employees, employees of a third party, or to other individuals with similar affiliations such as executive officers of a specific group.

Eligibility for employees is usually conditioned on the employee’s continued employment with the credit union.

The account-opening agreement must disclose the rate that represents the legal obligation between the parties—the credit union and the borrower—and it may include the lower preferential rate as well.

If the agreement refers to a preferential rate, it should also mention the requirements for obtaining and retaining the preferential rate.

For example, the agreement may provide that the preferential rate will increase from the reduced rate to the higher standard rate when employment is terminated or whenever the condition occurs that causes the loss of the preferential rate.

The provisions discussed here provide to all open-end loans except for home equity lines of credit.

Regulation Z requires that a 45-day notice of change in terms be provided before increasing the rate from the lower preferential rate to the higher standard rate that was disclosed in the account opening agreement.

If the creditor discloses the preferential rate in the initial account opening agreement, then the preferential rate must also be included in the summary table required for all open-end loans and in applications and solicitations for credit card accounts.

For preferential rates disclosed in the summary table, the creditor must briefly disclose beneath the table the circumstances that lead to the preferential rate being revoked. It must also disclose the rate that will apply afterwards.

If preferential rates are instead disclosed after account opening in an amendment to the account agreement, then the preferential rate is not required in the summary table.

A creditor may have two separate account opening agreements: One for the general membership that does not mention preferential rates, and one for employees and other parties which contains preferential rates.

You may want to check with your forms supplier regarding the separate documents.

Floor rates on open-end loans

Regulation Z provides that no notice of change in terms is required if an APR in a variable-rate account increases as a result of a rise in the index that’s not controlled by the creditor and is available to the general public, such as the prime rate.

The Fed issued a final rule in February 2010 that applied only to credit card accounts.  An index is under the creditor’s control when the account is subject to a floor rate that prevents the account from acting as a true variable rate account.

The February 2010 final rule required card issuers to eliminate floor rates on credit card accounts only.

However, the Fed actually intended the February 2010 final rule to apply to all open-end loan floor rates.

When the Fed realized its mistake, it issued a proposed rule in November 2010 and a final rule in April 2011, which became effective Oct. 1, 2011.

This final rule stated that a variable-rate open-end loan that is subject to a fixed minimum or floor does not meet the conditions of the exception to the advance-notice requirements of Regulation Z. It therefore requires a 45-day notice before any rate may be increased because of an index increase.

This rule also applies where the variable-rate account is based on the creditor’s internal index, such as one that’s based on the creditor’s cost of funds, because the index is under the creditor’s control.

For the advance-notice exception to apply, the creditor must eliminate floors on all open-end accounts and make sure it is using an external index such as the prime rate for variable-rate accounts.

MICHAEL McLAIN is CUNA’s senior federal compliance counsel. Contact him at 608-231-4185.