September 1996 -- Volume 13 Issue 4
State Law Changes
- ALASKA - Effective: July 3, 1996 *** Law Type: Sales Finance
- MINNESOTA - Effective: August 1, 1996 *** Law Type: Credit Insurance
- MISSOURI - Effective: August 28, 1996 *** Law Type: Sales Finance/Small Loan
- WEST VIRGINIA - Effective: September 1, 1996 *** Law Type: Regulated Loan
Other Items of Interest
State Law Changes..................
* ALASKA *
Effective: July 3, 1996 *** Law Type: Sales Finance
A provision of House Bill 319 allows the credit service charge on retail installment contracts, retail charge agreements, and revolving charge agreements to be any rate agreed to by the buyer and seller.
An amendment to the refund provision (Sec. 45.10.070) has generated confusion about acceptable methods of refunding precomputed retail installment agreements. The amended language prohibits the use of the Rule of 78's when the "service charge is computed as an add-on or simple interest basis..." but does not state any particular method as allowable.
Our understanding of the intent of the amendment, after discussions with the Office of Consumer Credit, was to allow simple interest retail contracts (i.e. non-precomputed transactions). It is possible that the use of the term "add-on" refers to precomputed interest and that the latent intent was to prohibit a Rule of 78's refund on a precomputed retail installment agreement that used a simple interest rate to compute the credit service charge.
* MINNESOTA *
Effective: August 1, 1996 *** Law Type: Credit Insurance
The Minnesota Statutes have been amended through the Session Laws of 1996. While this legislation addresses a number of issues, the major points of impact seem to involve credit life insurance coverage amounts and premium calculations.
Even though the changes were effective August 1, 1996, clarification of several points is still being sought by many in the credit insurance industry. The major points of interest at this time are:
* The premium may be calculated on the scheduled indebtedness plus an amount equal to one monthly payment. It is not clear at this time whether the wording of the statute merely permits this coverage or mandates it.
* Discount points may not be included in the amount on which credit life insurance premiums are calculated.
We will keep you informed of further developments and clarifications as we continue discussions with the Department of Commerce and insurers in the industry.
* MISSOURI *
Effective: August 28, 1996 *** Law Type: Sales Finance
The maximum time charge allowed on a retail installment sales contract will be deregulated on August 28, 1996. At that time any charge agreed to by the buyer and seller is allowed. A minimum time charge of $12 will also be allowed.
The current retail installment sales maximum rates are a split add-on structure of 15%/12%/10% - $750/$1,000/$7,500
Effective: August 28, 1996 *** Law Type: Small Loan
The maximum delinquency charge for a consumer small loan will increase to 5% of the payment due or $25, whichever is less. Currently the maximum is the lesser of 5% or $15.
* WEST VIRGINIA *
Effective: September 1, 1996 *** Law Type: Regulated Loan
Senate Bill 366 has repealed the Industrial Loan Law and now governs Regulated Consumer Lenders under the state's Consumer Credit and Protection Act. The maximum rates for Regulated Consumer Lenders will be:
| * | Loans of $2,000 or less | 31% | |
| * | Loans greater than $2,000 | 27% | |
| * | Loans greater than $10,000 | 18% | |
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Any closed-end loan greater than $2,000 may include a charge of 2% of the amount financed for origination fees, investigation fees, and/or points. |
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Any secured loan may include a charge of 5% of the amount financed for origination fees, investigation fees, and/or points. |
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From Our Research Dept....
"No Interest" and the A.P.R. -- Part II
In our April issue, we discussed the growing trend among retailers of offering "no interest" grace periods when financing purchases as an enticement to attract customers. While this practice is not limited solely to sales finance transactions, we recently completed software for a bank which was offering an interest-free first period on consumer loans, it is definitely much more prevalent in conjunction with retail sales financing.
These types of transactions generally fall into two categories: same-as-cash first intervals and truly interest-free first intervals.
The same-as-cash transaction will accrue no interest through the advertised grace period (let's say for purposes of illustration the advertised "interest free" period is 6 months). If the consumer pays the entire amount outstanding prior to the end of the grace period, there are no interest charges. However, the creditor earns 6 months and 1 day of interest on the day following the end of the stated grace period.In contrast, the interest-free scenario provides a grace period that accrues no interest charges regardless of when the first payment is actually made. The creditor earns 1 day of interest on the day following the end of the stated grace period.
The examples we posed for illustration in the April issue
had the following data common to both scenarios:
| Date of Contract | 03/20/1996 | |
| Date of 1st Payment | 09/20/1996 | |
| Simple Interest Rate | 14% | |
| Amount Financed | $2,000.00 | |
| Number of Monthly Payments | 12 | |
Since the Truth-in-Lending Annual Percentage Rate was designed to provide a common denominator for consumers to evaluate prospective credit transactions, how well does the A.P.R. help consumers evaluate the twotypes of transactions outlined above?
EXHIBIT 1
Truth-in-Lending Disclosures
6 Months "Same as Cash"
| Amount Financed | $2,000.00 | |
| Finance Charge | $279.04 | |
| Total of Payments | $2,279.04 | |
| Monthly Payment | $189.92 | |
| A.P.R. | 13.7883% |
This transaction, in effect, becomes a traditional consumer credit transaction with a 6 month first interval if the consumer fails topay within the designated grace period. If the consumer pays in full within the 6 month first period, it is treated as a cash transaction. In some instances, a minimum interest paymentis due during the grace period and the entire chargethat is collected would be refunded if payment in full is made within the stated 6 month time frame.
The properly rounded A.P.R. would be disclosed as 13.79%. This value is slightly lower than the 14% computational interest rate and reflects the fact that the consumer has use of the merchandise, although with associated finance charge costs, for a longer period of time than the customary one month.
EXHIBIT 2
Truth-in-Lending Disclosures
6 Months "Interest Free"
| Amount Financed | $2,000.00 | |
| Finance Charge | $154.84 | |
| Total of Payments | $2,154.84 | |
| Monthly Payment | $179.57 | |
| A.P.R. | 7.8329% |
The difference between the computational interest rate of 14% and the disclosed A.P.R. of 7.83% is striking. However, remember that the A.P.R. represents the cost of credit as a yearly percentage and in this case the consumer has use of the merchandise without charge for 6 months. In that case, the creditor should be allowed to recognize that fact through the disclosed annual percentage rate.
Both of the above annual percentage rates were computed according to the formulas in Appendix J to Regulation Z.
Given these two examples, the conclusion must be drawn that the Truth-in-Lending Annual Percentage Rate does provide an accurate reflection of the cost of credit.
A key point for creditors to recognize is that these two scenarios are often described and advertised with indistinguishable labels and phrases. It is imperative that creditors know which of these two typesof transactions they are offering. As we stated in Part I, Carleton has received many requests for an "interest free" first period only to find upon further investigation that the transaction actually had the characteristics of a "same as cash" deal. As this exercise demonstrates, the difference in the disclosed A.P.R. can be dramatic.
The Carleton Research Department is currently working on a research report concerning A.P.R. calculations with an interest- free first period. The report is scheduled for completion in mid-October. If you would like a copy, call and ask for X-0573.
Distribution of this newsletter is made with the understanding that the information contained herein has not been certified as legally acceptable for any particular statute, law, or regulation. For more timely and detailed information, subscribe to our Consumer Finance Newsletter and/or The Cost of Personal Borrowing in the United States compliance guide which are both published and updated ten times a year.
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