Reg Z and floor rates on open-end loans
A review of the Federal Reserve's CARD Act requirements.
The Federal Reserve issued the requirements of the Credit Card Accountability Responsibility and Disclosure (CARD) Act of 2009 in three stages.
The first stage became effective in August 2009, and the second and third stages became effective in February and June 2010, respectively.
However, most CARD Act requirements were contained in the second stage that became effective in February 2010.
After publication of the February and June 2010 final rules, the Fed became aware it needed to provide further clarification to resolve confusion regarding how institutions must comply with certain requirements within those two final rules.
As a result, the Fed issued a proposed rule in November 2010 and a final rule in April 2011 to clarify certain requirements. The April 2011 final rule became effective Oct. 11, 2011.
One of these requirements in Section 226.55(b)(2)*, which applies only to credit card accounts (not other open-end loans), provides that a card issuer may increase an annual percentage rate (APR) when the rate varies according to an index that is not under the card issuer’s control and is available to the general public, and the rate increase is due to an increase in that index.
Further, a true variable-rate increase as described above is provided an exception to the change-in-terms notice requirements which would ordinarily require a 45-day advance notice of change in terms before a rate can be increased or a fee added or increased.
However, an index would be under the card issuer’s control if the index is based on the card issuer’s own prime rate or cost of funds, or the index is subject to a fixed minimum rate or similar requirement (such as a floor) that does not permit the variable rate to decrease consistent with reductions in the index.
When the index is under the card issuer’s control, the account is no longer entitled to the exception from the notice requirements and a card issuer would have to provide a 45-day advance notice of change in terms prior to increasing the rate due to an increase in the index.
NEXT: An example
* Later renumbered 1026.55 (b)(2) by the Consumer Financial Protection Bureau when the agency renumbered Regulation Z.
For example, assume an issuer offers a variable-rate credit card account with a rate of 13%, which is calculated by adding a margin of seven percentage points to an index with a current value of 6%.
However, the terms of the account provide for a “floor” that prevents the variable rate from falling below 13%.
Therefore, the variable rate can only increase, and the cardholder will not benefit if the value of the index falls below 6%. That’s because the floor prevents the rate from decreasing the same as a true variable-rate account should.
The final rule permits a card issuer to use a published prime rate such as that in The Wall Street Journal. Although a publicly available index need not be published in a newspaper, it must be one the consumer can independently obtain and use to verify the APR on the account.
As a practical matter, section 55(b)(2) precluded card issuers from imposing a variable rate that is subject to a fixed minimum or “floor” rate.
Therefore, the February 2010 final rule required card issuers to eliminate floor rates on credit card accounts.
Because the February 2010 final rule applied these requirements to credit card accounts, the April 2011 final rule clarified that these requirements also apply to all other open-end loans except home equity lines of credit (HELOC).
The April 2010 final rule also stated that Regulation Z does not prohibit variable rates that are subject to a minimum or “floor,” but accounts with a floor rate must comply with the advance notice requirements of Section 1026.9(c).
In other words, any variable-rate open-end loan with a floor (except a HELOC) must provide a 45-day advance notice of change in terms before increasing the rate due to an increase in the index.
A card issuer that wishes the advance notice exception to apply to their variable-rate open-end loans must eliminate any floor rate on the variable-rate loan.
The elimination of a floor rate is beneficial for cardholders, so no notice under Regulation Z would be required.
However, even though a notice is not required when the issuer eliminates a floor rate, a credit union may wish to let members/cardholders know anyway to garner positive publicity.
Finally, if a credit union eliminates a floor rate, it may need to amend its loan documents to eliminate any reference to that rate.
MIKE McLAIN is CUNA’s senior federal compliance counsel.