TILA Supplemental Manual

8/14/2019 TILA Supplemental Manual

1/37

Regulation Z

Truth in Lending

Background

Regulation Z (12 CFR 226) implements the Truth inLending Act (TILA) (15 USC 1601 et seq.), whichwas enacted in 1968 as title I of the ConsumerCredit Protection Act (Pub. L. 90-321). Since itsimplementation, the regulation has been amendedmany times to incorporate changes to the TILA orto address changes in the consumer creditmarketplace.

Regulation Z was first revised in 1970 to prohibitcreditors from sending consumers unsolicited creditcards. Subsequent revisions to the regulation in the1970s implemented billing dispute provisions of theFair Credit Billing Act of 1974 and the ConsumerLeasing Act of 1976.

During the 1980s, Regulation Z was changedsignificantly, first in connection with the Truth inLending Simplification and Reform Act of 1980. In1981, all consumer leasing provisions in theregulation were transferred to the Boards Regulation M. During the late 1980s, Regulation Z wasamended to implement the rate limitations forhome-secured loans set forth in section 1204 of theCompetitive Equality Banking Act of 1987 and torequire disclosures for adjustable-rate mortgageloans. Other Regulation Z amendments implemented the Fair Credit and Charge Card DisclosureAct of 1988 and the Home Equity Loan Consumer

Protection Act of 1988, which required disclosure ofkey terms at the time of application.

In the 1990s, Regulation Z was amended toimplement the Home Ownership and Equity Protection Act of 1994, which imposed new disclosurerequirements and substantive limitations on certainhigher-cost closed-end mortgage loans andincluded new disclosure requirements for reversemortgage transactions. The regulation was alsorevised to reflect the 1995 Truth in Lendingamendments that dealt primarily with tolerances forloans secured by real estate and limitations onlenders liability for disclosure errors for these typesof loans. Regulation Z amendments resulting fromthe Economic Growth and Regulatory PaperworkReduction Act of 1996 simplified adjustable-ratemortgage disclosures.

Applicability

In general, Regulation Z applies to individuals andbusinesses that offer or extend credit, when all thefollowing conditions are met:

The credit is offered or extended to consumers

Consumer Compliance Handbook Reg. Z 1 (1/06)

The offering or extension of credit is doneregularly (see the definition of creditor in

section 226.2(a))

The credit is subject to a finance charge or ispayable by a written agreement in more than fourinstallments

The credit is primarily for personal, family, orhousehold purposes

The regulation also includes special provisions forcredit offered by credit card issuers and specificrequirements for persons who are not creditors butwho provide applications for home equity loans.

Organization of Regulation Z

The disclosure rules of Regulation Z differ depending on whether the credit is open-end (credit cardsand home equity lines, for example) or closed-end(such as car loans and mortgages). Regulation Z isstructured accordingly.

Subpart AProvides general information thatapplies to both open-end and closed-end credittransactions, including definitions, explanationsof coverage and exemptions, and rules fordetermining which fees are finance charges

Subpart BCovers open-end credit, includinghome equity loans and credit and chargeaccounts; sets forth rules for providing disclosures, resolving billing errors, calculating annualpercentage rates and credit balances, andadvertising; describes special rules for creditcard transactions (such as prohibitions on theissuance of credit cards and restrictions on theright to offset a cardholders indebtedness); andprovides special rules for home equity lines ofcredit (such as prohibitions against closingaccounts and changing account terms)

SubpartCCovers closed-end credit, includingresidential mortgage transactions, demand loans,and installment credit contracts (including direct

loans by banks and purchased dealer paper);sets forth rules for disclosures related to regularand variable-rate loans, refinancings and assumptions, and credit balances; also gives rulesfor calculating annual percentage rates andadvertising closed-end credit

Subpart DFor both open- and closed-endcredit, sets forth the duty of creditors to retainevidence of compliance with the regulation,clarifies the relationship between the regulationand state law, and requires creditors to set an


2/37

Truth in Lending

interest rate cap for variable-rate transactionssecured by a consumers dwelling

SubpartERequires additional disclosures for,sets limits on, and prohibits specific acts andpractices in connection with certain home mortgage transactions having rates or fees above a

certain percentage or amount; also sets forthdisclosure requirements for reverse mortgagetransactions (both open- and closed-end credit)

AppendixesProvide model forms and clausesthat creditors may use when providing disclosures; detailed rules for calculating APRs foropen- and closed-end credit; and instructionsfor computing the total annual loan cost ratefor reverse mortgage transactions, along withtables giving assumed loan periods for thosetransactions

OfficialstaffinterpretationsPublished in a commentary normally updated annually, in March;include mandates concerning disclosures not

necessarily explicit in the regulation and information on other actions required of creditors (Goodfaith compliance with the commentary protectscreditors from civil liability under the act; it isvirtually impossible to comply with the regulationwithout reference to, and reliance on, thecommentary.)

Note:Thischapterdoesnotattempt todiscussallof Regulation Z, but rather highlights areas thathave caused the most problems in relation tocalculation of the finance charge and the annualpercentagerate.

General Information (Subpart A)

Purpose of the TILA and Regulation Z

The Truth in Lending Act is intended to ensure thatcredit terms are disclosed in a meaningful way sothat consumers can compare credit terms morereadily and more knowledgeably. Before its enactment, consumers were faced with a vast array ofcredit terms and rates. It was difficult to compareloans because the terms and rates were seldompresented in the same format. Now, all creditorsmust use the same credit terminology and expressions of rates. In addition to providing a uniformsystem for disclosures, the act is designed to

Protect consumers from inaccurate and unfaircredit billing and credit card practices

Provide consumers with rescission rights

Provide for rate caps on certain dwelling-secured loans

Impose limitations on home equity lines of creditand certain closed-end home mortgages

2 (1/06) Reg. Z Consumer Compliance Handbook

The TILA and Regulation Z do not tell financialinstitutions how much interest they may charge orwhether they must grant a loan to a particularconsumer.

Coverage and Exemptions

( 226.1226.3)Lenders must carefully consider several factorswhen deciding whether a loan requires Truth inLending disclosures or is subject to other Regulation Z requirements. Broad coverage considerations are included in section 226.1(c) of theregulation, and relevant definitions appear insection 226.2. Coverage considerations areaddressed in more detail in the commentary to theregulation.

The following transactions are exempt fromRegulation Z under section 226.3:

Credit extended primarily for a business, commercial, or agricultural purpose

Credit extended to other than a natural person(including credit to government agencies orinstrumentalities)

Credit in excess of $25,000 not secured by realor personal property used as the consumersprincipal dwelling

Public utility credit

Credit extended by a brokerdealer registeredwith the Securities and Exchange Commission orthe Commodity Futures Trading Commissioninvolving securities or commodities accounts

Home fuel budget plans Certain student loan programs

Footnote 4 in Regulation Z provides that if acredit card is involved, credit that is generallyexempt from the requirements of Regulation Z (forexample, credit for a business or agriculturalpurpose) is still subject to requirements that governthe issuance of credit cards and liability for theirunauthorized use. (Credit cards must not be issuedon an unsolicited basis, and if a credit card is lostor stolen, the cardholder must not be held liable formore than $50 for the unauthorized use of thecard.)

When determining whether credit is for consumerpurposes, the creditor must evaluate the followingfive factors:

Information obtained from the consumer describing the purpose of the loan proceeds

A statement that the proceeds will be used fora vacation trip, for example, would indicate aconsumer purpose.

If the consumer states that the loan has amixed purpose (for example, that the pro-


3/37

Truth in Lending

ceeds will be used to buy a car that will beused for both personal and business purposes), the lender must look to the primarypurpose of the loan to decide whether disclosures are necessary. A statement of purposeby the consumer will help the lender make thatdecision.

A checked box indicating that the loan is for abusiness purpose could, absent any documentation showing the intended use of the proceeds, be insufficient evidence that the loandoes not have a consumer purpose.

The consumers primary occupation and how itrelates to the use of the loan proceeds

The higher the correlation between the consumers occupation and the property purchased from the loan proceeds, the greaterthe likelihood that the loan has a businesspurpose. For example, proceeds used topurchase dental supplies for a dentist would

indicate a business purpose.

Personal management of the assets purchasedfrom the loan proceeds

The less the borrower is personally involved inthe management of the investment or enterprise purchased by the proceeds, the lesslikely the loan has a business purpose. Forexample, borrowing money to purchase stockin an automobile company by an individualwho does not work for that company wouldindicate a personal investment and a consumer purpose.

The size of the transaction

The larger the transaction, the more likely theloan has a business purpose. For example, aloan amount of $5,000,000 for a real estatetransaction might indicate a business purpose.

The amount of income derived from the propertyacquired by the loan proceeds relative to theborrowers total income

The less the income derived from the acquiredproperty, the more likely the loan has aconsumer purpose. For example, if the borrower has an annual salary of $100,000,receiving about $500 in annual dividends fromthe acquired property would indicate a consumer purpose.

The lender must evaluate all five factors beforeconcluding that disclosures are not necessary.Normally, evidence suggested by a single factor is,by itself, insufficient to draw a conclusion aboutwhether the transaction is covered by Regulation Z.The diagram Coverage Considerations underRegulation Z may be helpful in making thedetermination. In any case, the financial institution

may choose to furnish disclosures to consumers.Disclosure under such circumstances does notcontrol whether the transaction is covered but canensure protection to the financial institution andcompliance with the law.

Determination of theFinance Charge and the APR

Finance Charge (Open-End andClosed-End Credit) ( 226.4)

The finance charge is a measure of the cost ofconsumer credit represented in dollars and cents.Along with APR disclosures, the disclosure of thefinance charge is central to the uniform credit costdisclosure envisioned by the TILA.

Generally, the finance charge includes any

charges or fees payable directly or indirectly by theconsumer and imposed directly or indirectly by thefinancial institution either incident to or as acondition of an extension of consumer credit. Forexample, the finance charge on a loan alwaysincludes any interest charges and, often, othercharges, such as points, transaction fees, orservice fees.

Regulation Z provides examples, applicable toboth open-end and closed-end credit transactions,of what must, must not, or need not be included inthe disclosed finance charge (section 226.4(b)).

The finance charge does not include any charge

of a type payable in a comparable cash transaction, such as taxes, title fees, license fees, orregistration fees paid in connection with an automobile purchase.

Calculationof theFinanceCharge(Closed-EndCredit)One of the more complex tasks under Regulation Zis determining whether a charge associated with anextension of credit must be included in, or excludedfrom, the disclosed finance charge. The financecharge initially includes any charge that is, or will

be, connected with a specific loan. Chargesimposed by third parties are finance charges if theinstitution requires use of the third party. Chargesimposed by settlement or closing agents arefinance charges if the institution requires thespecific service that gave rise to the charge andthe charge is not otherwise excluded.

The Finance Charges diagram summarizesincluded and excluded charges and may behelpful in determining whether a loan-relatedcharge is a finance charge.



4/37

Truth in Lending

Coverage Considerations under Regulation Z

Yes

Yes

Is the creditfor personal,

family, orhousehold

use?

Is the creditextended to a

consumer?

Is the creditextended by a

creditor?

Isthe loan

or credit plansecured by real prop-erty or by the con-sumers principal

dwelling?

Yes

Regulation Z does not apply, except the rules concerning issu

ance of and unauthorized-use liability for credit cards. (ExemptNo credit includes loans with a business or agricultural purpose

and certain student loans. Credit extended to acquire or improve rental property that is not owner-occupied is considered

business-purpose credit.)

No Regulation Z does not apply. (Credit that is extended to a landtrust is deemed to be credit extended to a consumer.)

The institution is not a creditor and Regulation Z does not ap

ply unless at least one of the following tests is met:

(1) The institution extends consumer credit regularly and

(a) The obligation is initially payable to the institution and

(b) The obligation either is payable by written agreement

in more than four installments or is subject to a finance

charge

(2) The institution is a card issuer that extends closed-end

No credit that is subject to a finance charge or is payable bywritten agreement in more than four installments

(3) The institution is a card issuer that extends open-end

credit or credit that is not subject to a finance charge and

is not payable by written agreement in more than fourinstallments

For limited purposes, a person that honors a credit card may

also be a creditor.

(Note: All persons, including noncreditors, must comply with

the advertising provisions of Regulation Z.)

Yes Yes

Is the Regulation Z does not apply, but it may apply

later if the loan is refinanced for $25,000 oramount

No financed or Noless. If the principal dwelling is taken as col-

credit limitlateral after consummation, rescission rights

$25,000 orapply and, in the case of open-end credit,

less?billing disclosures and other provisions of

Regulation Z apply.

Regulation Z applies



5/37

Truth in Lending

Finance Charges

FINANCE CHARGE = DOLLAR COST OF CONSUMER CREDIT: Includes any charge payable directly or indirectly by the consumerand imposed directly or indirectly by the creditor as a condition of or incident to the extension of credit

CHARGES ALWAYSINCLUDED

(A)

Interest

Loan origination feesConsumer points

Credit-guaranteeinsurance premiums

Charges imposedon the creditor for

purchasing the loanthat are passed on to

the consumer

Discounts forinducing payment

by means other than

credit

Mortgage broker fees

Other examples: Feefor preparing TILAdisclosures; real

estate constructionloan inspection

fees; fees for post-consummation taxor flood insurance

requirements;required credit lifeinsurance charges

CHARGESINCLUDED UNLESSCONDITIONS ARE

MET

(B)

Premiums for creditlife, accident andhealth, or loss-ofincome insurance

Premiums forproperty or liability

insurance

Premiums forvendors singleinterest (VSI)

insurance

Security interestcharges (filing fees),

insurance in lieuof filing fees, and

certain notary fees

Charges imposed bythird parties

Charges imposed bythird-party closing

agents

Appraisal andcredit-report fees

CONDITIONSFOR EXCLUSION

(Any loan)

(C)

Insurance notrequired, disclosures

are made, andconsumer authorizes

Consumer selectsinsurance companyand disclosures are

made

Insurer waives rightof subrogation,

consumer selectsinsurance company,and disclosures are

made

The fee is forlien purposes, is

prescribed by law,is payable to a

public official, andis itemized and

disclosed

Use of the thirdparty is not requiredto obtain loan, andcreditor does notretain the charge

Creditor does notrequire and does notretain the fee for the

particular service

Application fees,if charged to all

applicants, are notfinance charges.

Application fees mayinclude appraisal or

credit-report fees

EXCLUDABLECHARGES*(Residentialmortgage

transactions andloans secured by real

estate)(D)

Fees for titleinsurance, title

examination, propertysurvey, etc.

Amounts required tobe paid into escrow,

if not otherwiseincluded in thefinance charge

Notary fees

Pre-consummation

flood and pestinspection fees

Appraisal and creditreport fees

CHARGES NEVERINCLUDED

(E)

Charges payable ina comparable cash

transaction

Sellers points

Participation ormembership fees

Discount offered bythe seller to inducepayment by cash

or other means notinvolving the use of a

credit card

Interest forfeited asa result of interestreduction required

by law

Charges absorbed bythe creditor as a cost

of doing business

Transaction fees

Debt-cancellationfees

Coverage not

required, disclosuresare made, andconsumer authorizes

Fees for preparingloan documents,

mortgages, andother settlement

documentsOverdraft fees notagreed to in writing

Fees forunanticipated late

payments

*To be excludable, fees mustbe bona fide and reasonable.



6/37

Truth in Lending

Chargesalwaysincluded(col.A)Lists chargesgiven in the regulation or commentary asexamples of finance charges

Charges included unless conditions are met(col.B)Lists charges that must be included inthe finance charge unless the creditor meetsspecific disclosure or other conditions to excludethe charges from the finance charge

Conditions for exclusion (col. C)Notes theconditions that must be met if the charges listedin column B may be excluded from the financecharge. Although most charges in column B maybe considered part of the finance charge at thecreditors option, third-party charges and application fees must be excluded from the financecharge if the relevant conditions are met; however, inclusion of appraisal and credit-reportcharges as part of the application fee isoptional.

Excludable charges (col.D)Identifies fees orcharges that may be excluded from the financecharge if they are bona fide and reasonable inamount and the credit transaction is secured byreal property or is a residential mortgage transaction. For example, if a consumer loan issecured by a vacant lot or by commercialreal estate, any appraisal fees connected withthe loan may be excluded from the financecharge.

Chargesnever included (col.E)Lists chargesgiven in the regulation as examples of chargesthat automatically are not finance charges(for example, fees for unanticipated latepayments).

PrepaidFinanceCharges(226.18(b))A prepaid finance charge is any finance chargethat (1) is paid separately to the financial institutionor to a third party, in cash or by check, before or atclosing, settlement, or consummation of a transaction or (2) is withheld from the proceeds of thecredit at any time. Prepaid finance charges effectively reduce the amount of funds available for theconsumers use, usually before or at the time thetransaction is consummated.

Examples of finance charges frequently prepaidby consumers are borrowers points, loan origination fees, real estate construction inspection fees,odd days interest (interest attributable to part of thefirst payment period when that period is longer thana regular payment period), mortgage guaranteeinsurance fees paid to the Federal Housing Administration, private mortgage insurance paid to suchcompanies as the Mortgage Guaranty InsuranceCompany, and, in non-real-estate transactions,credit-report fees.

PrecomputedFinanceChargesA precomputedfinancechargeincludes, for example, interest added to the note amount that iscomputed by the add-on, discount, or simpleinterest method. If reflected in the face amount ofthe debt instrument as part of the consumers

obligation, finance charges that are not viewed asprepaid finance charges are treated as precomputed finance charges that are earned over the lifeof the loan.

AccuracyTolerances(Closed-EndCredit)(226.18(d)and226.23(h))The finance charge tolerances for closed-endcredit provided by Regulation Z are for legalaccuracy and should not be confused with thosetolerances provided in the TILA for reimbursementunder regulatory agency orders. As with disclosed

APRs, if a disclosed finance charge is legallyaccurate, it is not subject to reimbursement.

Generally, tolerances for finance charge errors ina closed-end transaction are $5 if the amountfinanced is $1,000 or less and $10 if the amountfinanced exceeds $1,000 (see diagrams on following pages). For certain transactions consummatedon or after September 30, 1995, the tolerances aredifferent, as noted below:

Credit secured by real property or a dwelling(closed-end credit only):

The disclosed finance charge is considered

accurate if it does not vary from the actualfinance charge by more than $100.

Overstatements are not violations.

Rescission rights after the three-business-dayrescission period (closed-end credit only):

The disclosed finance charge is consideredaccurate if it does not vary from the actualfinance charge by more than one-half of1 percent of the credit extended.

The disclosed finance charge is consideredaccurate if it does not vary from the actualfinance charge by more than 1 percent of thecredit extended for the initial and subsequent

refinancings of residential mortgage transactions when the new loan is made at a differentfinancial institution. (This category excludeshigh-cost mortgage loans subject to section226.32, transactions in which there are newadvances, and new consolidations.)

Rescission rights in foreclosure:

The disclosed finance charge is consideredaccurate if it does not vary from the actualfinance charge by more than $35.



7/37

Truth in Lending

Overstatements are not considered violations.

The consumer is entitled to rescind if amortgage broker fee is not included as afinance charge.

Note: Normally, the finance charge tolerance fora rescindable transaction is either 0.5 percent of

the credit transaction or, for certain refinancings,1 percent of the credit transaction. However,in the event of a foreclosure, the consumer mayexercise the right of rescission if the disclosedfinance charge is understated by more than$35.

Neither the TILA nor Regulation Z provides anytolerances for finance charge errors in open-endcredit disclosures. Open-end credit disclosuresmust be accurate.

Annual Percentage Rate(Closed-End Credit) ( 226.22)

Credit costs may vary depending on the interestrate, the amount of the loan and other charges, thetiming and amounts of advances, and the repayment schedule. The APR, which must be disclosedin nearly all consumer credit transactions, isdesigned to take into account all relevant factorsand to provide a uniform measure for comparingthe costs of various credit transactions.

The APR is a measure of the total cost of credit,expressed as a nominal yearly rate. It relates theamount and timing of value received by theconsumer to the amount and timing of paymentsmade by the consumer. The disclosure of the APRis central to the uniform credit cost disclosureenvisioned by the TILA.

The APR for closed-end credit must be disclosedas a single rate only, whether the loan has a singleinterest rate, a variable interest rate, a discountedvariable interest rate, or graduated paymentsbased on separate interest rates (step rates). Also,the APR must appear with the segregateddisclosuresdisclosures grouped together andnot containing any information not directly relatedto the disclosures required under section 226.18.

As the APR is a measure of the total cost of credit,including such costs as transaction charges and

premiums for credit-guarantee insurance, it is notan interestrate as that term is generally used. APRcalculations do not rely on definitions of interest instate law and often include charges, such as acommitment fee paid by the consumer, that are notviewed by some state usury statutes as interest.Conversely, APR calculations might not includecharges, such as a credit-report fee in a realproperty transaction, that some state laws view asinterest for usury purposes. Furthermore, measuring the timing of value received and of payments


made, which is essential if APR calculations are tobe accurate, must be consistent with parametersunder Regulation Z.

The APR is often considered to be the financecharge expressed as a percentage. However, twoloans could have the same finance charge and still

have different APRs because of differing values ofthe amount financed or differing payment schedules. For example, the APR on a loan with anamount financed of $5,000 and 36 equal monthlypayments of $166.07 each is 12 percent, while theAPR on a loan with an amount financed of $4,500and 35 equal monthly payments of $152.18 each,plus a final payment of $152.22, is 13.26 percent. Inboth cases the finance charge is $978.52. TheAPRs on these loans are not the same because anAPR reflects more than the finance charge. Itrelates the amount and timing of value received bythe consumer to the amount and timing of payments made by the consumer.

The APR is a function of

The amount financed, which is not necessarilyequivalent to the loan amount

If the consumer must pay a separate 1 percentloan origination fee (a prepaid finance charge)on a $100,000 residential mortgage loan atclosing, the loan amount is $100,000 but theamount financed is $100,000 less the $1,000loan fee, or $99,000.

The finance charge, which is not necessarilyequivalent to the total interest amount

If the consumer must pay a $25 credit-report

fee for an auto loan, the fee must be includedin the finance charge. The finance charge inthis case is the sum of the interest on the loan(that is, the interest generated by the application of a percentage rate against the loanamount) plus the $25 credit-report fee.

If the consumer must pay a $25 credit-reportfee for a home improvement loan secured byreal property, the credit-report fee must beexcluded from the finance charge. The financecharge in this case would be only the intereston the loan.

Interest, which is defined by state or otherfederal law but not by Regulation Z

The paymentschedule, which does not necessarily include only principal and interest (P + I)payments

If the consumer borrows $2,500 for a vacationtrip at 14 percent simple interest per annumand repays that amount with 25 equal monthlypayments beginning one month from consummation of the transaction, the monthly P + Ipayment would be $115.87, if all months areconsidered equal, and the amount financed
http:///reader/full/$152.22http:///reader/full/$978.52http:///reader/full/$115.87http:///reader/full/$115.87http:///reader/full/$978.52http:///reader/full/$152.22


8/37

Truth in Lending

Closed-End Credit: Accuracy Tolerances for Finance Charges

Is this a

closed-end credit TILA

claim asserting rescission

Yes Norights?

Finance charge Is the Is thetolerance is $35. rescission transaction

Did the

An overstated Yes claim a defense secured byYes transaction No

finance charge is to foreclosure real estate or aoriginate before

not considered a action? dwelling?9/30/95?

violation.

No

Is theNo

transaction arefinancing?

Yes

Finance chargetolerance is one-half of 1% of the Is theloan amount or transaction$100, whichever Yes a high-costis greater. mortgage loan?*

An overstatedfinance charge isnot considered aviolation.

No

Does therefinancing

Yes involve aconsolidation ornew advance?

No

No Yes

Finance chargetolerance is $200 forunderstatements.


Finance chargetolerance is $100 forunderstatements.

An overstated

finance charge isnot considered aviolation.

The finance chargeis consideredaccurate if it is notmore than $5 aboveor below the exact

finance charge in atransaction involvingan amount financedof $1,000 or less, ornot more than $10above or below theexact finance chargein a transactioninvolving an amountfinanced of morethan $1,000.

Finance chargetolerance is 1% ofthe loan amount or$100, whichever isgreater.


* See 15 USC 160(aa) and 12 CFR 226.32.



9/37

Truth in Lending

Closed-End Credit: Accuracy Tolerances forOverstated Finance Charges

Is the loan secured by realestate or a dwelling?

No Yes

Is the amount financed morethan $1,000?

No violation

No Yes

Is the disclosed finance Is the disclosed financecharge, less $5, more than charge, less $10, more thanthe correct finance charge? the correct finance charge?

No Yes No Yes

Finance chargeviolation

No violationFinance charge

No violationviolation



10/37

Truth in Lending

Closed-End Credit: Accuracy and Reimbursement Tolerances forUnderstated Finance Charges

Is the loan secured by realestate or a dwelling?

No Yes

Is the amount financedgreater than $1,000?

No Yes

No YesIs the disclosed finance Is the disclosed finance

charge understated by more charge understated by morethan $5? than $10?

Yes No No Yes

Finance charge Finance chargeNo violation No violation

violation violation

YesNo

No

Is the disclosed financecharge understated by morethan $100 (or $200 if the loanoriginated before 9/30/95)?

Finance chargeviolation

Is the loan term morethan 10 years?

Is the disclosed financecharge plus the financecharge reimbursement

tolerance (based on a one-quarter of 1 percentage pointAPR tolerance) less than the

correct finance charge?

NoYes

Is the loan a regular loan?

Yes

Is the disclosed financecharge plus the financecharge reimbursement

tolerance (based on a one-eighth of 1 percentage pointAPR tolerance) less than the

correct finance charge?

No Yes

No reimbursement

Subject to reimbursement



11/37

Truth in Lending

would be $2,500. If the consumers paymentsare increased $2.00 a month to pay anonfinanced $50 loan fee over the life of theloan, the amount financed would remain at$2,500 but the monthly payment wouldincrease to $117.87, the finance charge wouldincrease $50, and there would be a corre

sponding increase in the APR. This would bethe case whether or not state law defines the$50 loan fee as interest.

If the loan in the preceding example has 55days to the first payment and the consumerprepays interest at consummation ($24.31 tocover the first 25 days), the amount financedwould be $2,500 less $24.31, or $2,475.69.Although the amount financed is reducedbecause the amount available to the consumer at consummation is less, the timeinterval during which the consumer has use ofthe $2,475.6955 days to the first paymentis

unchanged. To ease creditor compliance,Regulation Z allows creditors to disregardcertain minor irregularities in the first paymentperiod (see section 226.17(c)(4)). In this case,however, because the first payment periodexceeds the limitations of the regulationsminor irregularities provisions, the first payment period of 55 days may not be treated asregular. In calculating the APR, the firstpayment period must not be reduced 25 days(that is, the first payment period may not betreated as one month).

Financial institutions may, if permitted by state orother law, precompute interest by applying a rate

against a loan balance using a simple interest,add-on, discount, or other method and may earninterest using a simple-interest accrual system, theRule of 78s (if permitted by law), or some othermethod. Unless the financial institutions internalinterest earnings and accrual methods involve asimple interest rate based on a 360-day year that isapplied over actual days (important only fordetermining the accuracy of the payment schedule), the institutions method of earning interest isnot relevant in calculating an APR, because an APRis not an interest rate (as that term is commonlyused under state or other law). As the APR normallyneed not rely on the internal accrual systems of a

financial institution, it may always be computedafter the loan terms have been agreed on (as longas it is disclosed before actual consummation ofthe transaction).

Special Requirements for Calculating theFinance Charge and APR

Proper calculation of the f inance charge and APR isvery important. Regulation Z requires that the terms

finance charge and annual percentage rate,when required to be disclosed with a corresponding amount or percentage rate, be disclosed moreconspicuously than any other required disclosure.The finance charge and APR, more than any otherdisclosures, enable consumers to understand thecost of the credit and to comparison shop for credit.

Failure to disclose those values accurately canresult in significant monetary damages to thecreditor, either from a class action lawsuit or from aregulatory agencys order to reimburse consumersfor violations of law.

Footnote 45d to section 226.22 states that if anannual percentage rate or finance charge isdisclosed incorrectly, the error is not, in itself, aviolation of the regulation if

The error resulted from a corresponding error ina calculation tool used in good faith by thefinancial institution

Upon discovery of the error, the financial institution promptly discontinues use of that calculationtool for disclosure purposes

The financial institution notifies the FederalReserve Board in writing of the error in thecalculation tool

When a financial institution claims that it used acalculation tool in good faith, it assumes a reasonable degree of responsibility for ensuring that thetool in question provides the accuracy required bythe regulation. To check on the tools accuracy, theinstitution might verify the results obtained usingthe tool with figures obtained using a different

calculation tool. It might also check that the tool, ifit is designed to operate under the actuarialmethod, produces figures similar to those providedby the examples in appendix J to the regulation. The calculation tool should be checked foraccuracy before it is first used and periodicallythereafter.

Open-End Credit (Subpart B)

This discussion does not address all the requirements for open-end credit in the Truth in LendingAct and Regulation Z. Instead, it focuses on some

of the more difficult issues presented in sections226.5 through 226.16 of the regulation. Additionalguidance is provided in the commentary for thesesections.

Finance Charge ( 226.6(a))

Each finance charge imposed must be individuallyitemized. An aggregate amount of the financecharge need not be disclosed.

http:///reader/full/$117.87http:///reader/full/$2,475.69http:///reader/full/$2,475.69http:///reader/full/$117.87


12/37

Truth in Lending

Determining theBalanceandComputing theFinanceChargeTo compute the finance charge, the examiner mustknow how to determine the balance to which theperiodic rate is applied. Common methods are theprevious balance method, the daily balance

method, and the average daily balance method.

PreviousbalancemethodThe balance to whichthe periodic rate is applied is the balanceoutstanding at the start of the billing cycle. Theperiodic rate is multiplied by this balance tocompute the finance charge.

Daily balance methodThe balance to whichthe periodic rate is applied is either the balanceon each day in the billing cycle or the sum of thebalances on each day in the cycle. If a dailyperiodic rate is multiplied by the balance oneach day in the billing cycle, the finance chargeis the sum of the products. If the daily periodic

rate is multiplied by the sum of all the dailybalances, the finance charge is the product.

AveragedailybalancemethodThe balance towhich the periodic rate is applied is the sum ofthe daily balances (either including or excludingcurrent transactions) divided by the number ofdays in the billing cycle. The periodic rate ismultiplied by the average daily balance todetermine the finance charge. If the periodic rateis a daily rate, the product of the rate multipliedby the average balance is multiplied by thenumber of days in the cycle.

In addition to those common methods, financial

institutions have other ways of calculating thebalance to which the periodic rate is applied. Byreading the institutions explanation, the examinershould be able to calculate the balance to whichthe periodic rate was applied. In some cases theexaminer may need to obtain additional informationfrom the institution to verify the explanation disclosed. Any inability to understand the disclosedexplanation should be discussed with management, who should be reminded of Regulation Zsrequirement that disclosures be clear andconspicuous.

If the balance is determined without first deducting all credits given and payments made during the

billing cycle, that fact, as well as the amounts of thecredits and payments, must be disclosed.

If the financial institution uses the daily balancemethod and applies a single daily periodic rate,disclosure of the balance to which the rate wasapplied may be stated as any of the following:

AbalanceforeachdayinthebillingcycleThedaily periodic rate is multiplied by the balance oneach day, and the sum of the products is thefinance charge.


Abalance for each day in the billing cycle onwhichthebalanceintheaccountchangesThedaily periodic rate is multiplied by the balance oneach day, and the sum of the products is thefinance charge, as above, but the statementshows the balance for only those days on whichthe balance changed.

ThesumofthedailybalancesduringthebillingcycleThe daily periodic rate is multiplied bythe sum of all the daily balances in the billingcycle, and that product is the finance charge.

The average daily balance during the billingcycleIf this balance is the one disclosed, theinstitution must explain somewhere on the periodic statement or in an accompanying documentthat the finance charge is or may be determinedby multiplying the average daily balance by thenumber of days in the billing cycle rather thanby multiplying the product by the daily periodicrate.

If the financial institution uses the daily balancemethod but applies two or more daily periodicrates, the sum of the daily balances may not beused. Acceptable ways of disclosing the balancesinclude

Abalanceforeachday inthebillingcycle Abalance for each day in the billing cycle onwhichthebalance intheaccountchanged

Two or more average daily balancesIf thebalance is disclosed in this way, the institutionmust indicate on the periodic statement or in anaccompanying document that the finance charge

is or may be determined by (1) multiplying eachof the average daily balances by the number ofdays in the billing cycle (or if the daily rate varies,multiplying the number of days that the applicable rate was in effect), (2) multiplying each of theresults by the applicable daily periodic rate, and(3) summing the products.

In explaining the method used to determine thebalance on which the finance charge is computed,the financial institution need not reveal how itallocates payments or credits. That informationmay be disclosed as additional information, but allrequired information must be clear and conspicuous.

FinanceChargeResulting fromTwoorMorePeriodicRatesSome financial institutions use more than oneperiodic rate in computing the finance charge. Forexample, one rate may apply to balances up to acertain amount and another rate to balances overthat amount. If two or more periodic rates apply, theinstitution must disclose all rates and conditions.The range of balances to which each rate appliesmust also be disclosed. It is not necessary,


13/37

1. If the applicable balance is zero, the APR cannot bedetermined.

2. See footnote 1.3. Loan fees, points, or similar finance charges that relate to the

opening of the account must not be included in the calculation ofthe APR.

4. See footnote 1.5. See footnote 3.

Truth in Lending

however, to break the finance charge into separatecomponents based on the different rates.

Annual Percentage Rate

AccuracyTolerance(226.14)The disclosed annual percentage rate on anopen-end credit account is considered accurate ifit is within one-eighth of 1 percentage point of theAPR calculated under Regulation Z.

DeterminingtheAPRRegulation Z describes two basic methods fordetermining the APR in open-end credit transactions. One method involves multiplying each periodic rate by the number of periods in a year. Thismethod is used for disclosing

The corresponding APR in initial disclosures

The corresponding APR on periodic statements

The APR in early disclosures for credit cardaccounts

The APR in early disclosures for home equityplans

The APR in advertising

The APR in oral disclosures

The corresponding APR is prospective. In otherwords, it is not based on the accounts actualoutstanding balance and the finance charges thatare imposed.

The other method is the quotient method, used incomputing the APR for periodic statements. Thequotient method reflects the annualized equivalentof the rate that was actually applied during a cycle.This rate, also known as the historical APR, willdiffer from the corresponding APR if the creditorapplies minimum, fixed, or transaction charges tothe account during the cycle.

If the finance charge is determined by applyingone or more periodic rates to a balance and doesnot include any of those charges (minimum, fixed,or transaction), the financial institution may compute the historical rate using the quotient method.In the quotient method, the total finance charge for

the cycle is divided by the sum of the balances towhich the periodic rates were applied, and thequotient (expressed as a percentage) is multipliedby the number of cycles in a year.

Alternatively, the financial institution may compute the historical APR using the method forcomputing the corresponding APR. In that method,each periodic rate is multiplied by the number ofperiods in one year. If the finance charge includesa minimum, fixed, or transaction charge, theinstitution must use the appropriate variation of the

quotient method. When transaction charges areimposed, the financial institution should refer toappendix F to Regulation Z for computationalexamples.

Regulation Z also contains a computation rule forsmall finance charges. If the finance charge

includes a minimum, fixed, or transaction chargeand the total finance charge for the cycle does notexceed 50 cents, the financial institution maymultiply each applicable periodic rate by thenumber of periods in a year to compute the APR.

Regulation Z also provides optional calculationmethods for accounts involving daily periodic rates(see section 226.14(d)).

CalculatingtheAPR forPeriodicStatementsNote:Assumemonthlybillingcyclesforeachofthecalculations.

I. APR when finance charge is determined solelyby applying one or more periodic rates

A. Monthly periodic rates

1. Monthly rate 12 = APRor

2. (Total finance charge Applicable balance) 12 = APR1

The preceding calculations may be usedwhen different rates apply to differentbalances.

B. Daily periodic rates

1. Daily rate x 365 = APRor

2. (Total finance charge Average dailybalance) 12 = APRor

3. (Total finance charge Sum of balances)365 = APR

II. APR when finance charge includes a minimum,fixed, or other charge that is not calculatedusing a periodic rate (and does not includecharges related to a specific transaction, suchas a cash advance fee)

A. Monthly periodic rates

1. (Total finance charge Amount of applicable balance2) 12 = APR3

B. Daily periodic rates

1. (Total finance charge Amount of applicable balance) 365 = APR4, 5



14/37

6. See footnote 1.7. See footnote 1.8. The sum of the balances may include amounts computed by

either the average daily balance, adjusted balance, or previousbalance method. When a portion of the finance charge isdetermined by application of one or more daily periodic rates, thesum of the balances also means the average of daily balances.

9. If the product is less than the highest periodic rate applied,expressed as an APR, the higher figure must be disclosed as theAPR.

Truth in Lending

2. The following may be used if at least aportion of the finance charge is determined by the application of a dailyperiodic rate. If not, use the formulaabove.

a. (Total finance charge Average dailybalance) x 12 = APR6

orb. (Total finance charge Sum of bal

ances) x 365 = APR7

C. Monthly and daily periodic rates

1. If the finance charge imposed during thebilling cycle does not exceed 50 centsfor a monthly or longer billing cycle (or aprorated part of 50 cents for a billingcycle shorter than one month), the APRmay be calculated by multiplying themonthly rate by 12 or the daily rate by365.

III. If the total finance charge includes a chargerelated to a specific transaction (such as a cashadvance fee), even if the total finance chargealso includes any other minimum, fixed, or othercharge not calculated using a periodic rate,then the monthly and daily APRs are calculatedas follows: (Total finance charge The greaterof (1) the transaction amounts that created thetransaction fees or (2) the sum of the balancesand other amounts on which a finance chargewas imposed during the billing cycle8) multiplied by the number of billing cycles in a year(12) = APR.9

Closed-End Credit (Subpart C)

The information presented here does not provide acomplete discussion of the closed-end creditrequirements of the Truth in Lending Act. Instead, itis offered to clarify otherwise confusing terms andrequirements. Refer to sections 226.17 through226.24 of Regulation Z and related commentary fora more thorough understanding of the act.

Finance Charge ( 226.17(a))

The total amount of the finance charge must bedisclosed. Each finance charge imposed need not

be individually itemized and must not be itemizedwith the segregated disclosures.


Annual Percentage Rate ( 226.22)

AccuracyTolerancesThe disclosed APR on a closed-end transaction isconsidered accurate

If for regular transactions (including any single-advance transaction with equal payments andequal payment periods or transactions with anirregular first or last payment and/or an irregularfirst payment period), the APR is within one-eighth of 1 percentage point of the APR calculated under Regulation Z (section 226.22(a)(2))

If for irregular transactions (including multiple-advance transactions and other transactions notconsidered regular), the APR is within one-quarter of 1 percentage point of the APRcalculated under Regulation Z (section226.22(a)(3))

If for mortgage transactions, the APR is withinone-eighth of 1 percentage point for regulartransactions or one-quarter of 1 percentagepoint for irregular transactions and The rate results from the disclosed finance

charge and

The disclosed finance charge would be considered accurate under section 226.18(d)(1)or section 226.23(g) or (h) of Regulation Z(section 226.22(a)(4))

Note: An additional tolerance is granted formortgage loans when the disclosed financecharge is calculated incorrectly but is considered accurate under section 226.18(d)(1) or

section 226.23(g) or (h) of Regulation Z (section 226.22(a)(5)).

See the diagrams for more information on accuracytolerances.

Construction Loans ( 226.17(c)(6)and Appendix D)

Construction loans and certain other multiple-advance loans pose special problems in computing the finance charge and the APR. In manyinstances, the amount and dates of advances arenot predictable with certainty because they depend

on the progress of the work. Regulation Z providesthat, for disclosure purposes, the APR and financecharge for such loans may be estimated.

A financial institution may, at its option, rely on therepresentations of other parties to acquire necessary information (for example, it might look to theconsumer for the dates of advances). In addition, ifany of the amounts or the dates of advances areunknown (even if some of them are known), theinstitution may, at its option, refer to appendix D tothe regulation to make calculations and disclo-


15/37

Truth in Lending

Closed-End Credit: Accuracy Tolerances for Overstated APRs

Is this a regular loan?(12 CFR 226, footnote 46)

No Yes

Is the disclosed APR more than the correct APR bymore than one-quarter of

1 percentage point?

Is the disclosed APR more than the correct APR bymore than one-eighth of

1 percentage point?

YesNoYes No

No violation

Is the loan secured by real estate or a dwelling?

YesNo

Is the disclosed financecharge more than the correct

finance charge?

APR violation

APR violation

Was the finance chargedisclosure error the cause of

the APR disclosure error?

No Yes

APR violation No violation

Yes No



16/37

Truth in Lending

Closed-End Credit: Accuracy and Reimbursement Tolerancesfor Understated APRs

Is this a regular loan?

No Yes

Is the disclosed APR understated by more than one-quarter

of 1 percentage point?

Is the disclosed APR understated by more than one-eighthof 1 percentage point?

Is the loan secured by real estate or a dwelling?

YesNo

YesNoYes No

Is the finance charge understated by more than $100 if the loan originated on or after 9/30 /95? $200 if the loan originated before 9/30/ 95?

APR violation

APR violation

Was the finance charge disclosure error thecause of the APR disclosure error?

No Yes

APR violation No violation

YesNo

No violation

Is the loan term greater than 10 years?

Is the loan a regular loan?

YesNo

YesNo

Is the disclosed APR Is the disclosed APR

understated by more than one- understated by more than one-quarter of 1 percentage point? eighth of 1 percentage point?

No reimbursement

Subject to reimbursement

YesNoNoYes



17/37

Truth in Lending

sures. The finance charge and payment scheduleobtained by referring to appendix D may be usedwith volume 1 of the Boards APR tables or with anyother appropriate computation tool to determinethe APR (the Boards APR tables are availablethrough the System publications catalog on theNew York Reserve Banks web site). If the institution

elects not to use appendix D, or if appendix Dcannot be applied to a loan (for example, appendixD does not apply to a combined constructionpermanent loan if the payments for the permanentloan begin during the construction period), theinstitution must make its estimates under section226.17(c)(2) and calculate the APR using multiple-advance formulas.

For loans involving a series of advances underan agreement to extend credit up to a certainamount, a financial institution may treat all theadvances as a single transaction or disclose eachadvance as a separate transaction. If advances are

disclosed separately, disclosures must be provided before each advance occurs, and thedisclosures for the first advance must be providedbefore consummation.

In a transaction that finances the construction ofa dwelling that may or will be permanently financedby the same financial institution, the constructionpermanent financing phases may be disclosed inone of the following ways:

As a single transaction, with one disclosurecovering both phases

As two separate transactions, with one disclosure for each phase

As more than two transactions, with one disclosure for each advance and one for thepermanent-financing phase

If two or more disclosures are furnished, buyerspoints or similar amounts imposed on the consumer may be allocated among the transactions inany manner the financial institution chooses, aslong as the charges are not applied more thanonce. In addition, if the financial institution choosesto give two sets of disclosures and the consumer isobligated for both construction and permanentphases at the outset, both sets of disclosures mustbe given to the consumer initially, before consum

mation of each transaction occurs.

If the creditor requires interest reserves forconstruction loans, special rules set forth in appendix D to Regulation Z apply that can make thedisclosure calculations quite complicated. Theamount of interest reserves included in the commitment amount must not be treated as a prepaidfinance charge.

If the lender uses appendix D for construction-only loans with required interest reserves, construc-


tion interest must be estimated using the interest-reserve formula in appendix D. The lenders owninterest-reserve values must be completely disregarded for disclosure purposes.

If the lender uses appendix D for combinationconstructionpermanent loans, the calculations

can be much more complex. The appendix is usedto estimate the construction interest, which is thenmeasured against the lenders contractual interestreserves.

If the interest-reserve portion of the lenderscontractual-commitment amount exceeds theamount of construction interest estimated underappendix D, the excess value is considered part ofthe amount financed if the lender has contracted todisburse those amounts, whether or not theyultimately are needed to pay for accrued construction interest. If the lender will not disburse theexcess amount if it is not needed to pay for accruedconstruction interest, the excess amount must be

ignored for disclosure purposes.

Calculating the Annual Percentage Rate( 226.22)

The APR must be determined under one of thefollowing methods:

The actuarial method, which is defined byRegulation Z and explained in appendix J to theregulation

The U.S. Rule, which is permitted by RegulationZ and is briefly explained in appendix J to the

regulation (The U.S. Rule is an accrual methodthat seems to have first surfaced officially in anearly nineteenth century U.S. Supreme Courtcase, Storyv.Livingston(38 U.S. 359).)

Whichever method the financial institution uses, therate calculated will be considered accurate if it isable to amortize the amount financed whilegenerating the finance charge under the accrualmethod selected. Institutions also may rely onminor irregularities and accuracy tolerances in theregulation, both of which effectively permit thedisclosure of somewhat imprecise, but still legal,APRs.

360-Day and 365-Day Years( 226.17(c)(3))

Confusion often arises over whether to use a360-day or 365-day year in computing interest,particularly when the finance charge is computedby applying a daily rate to an unpaid balance.Many single-payment loans and loans payable ondemand are in this category. Also in this categoryare loans that call for periodic installment payments.


18/37

Truth in Lending

Regulation Z does not require the use of onemethod of interest computation in preference toanother (although state law may). It does, however,permit financial institutions to disregard the fact thatmonths have different numbers of days whencalculating and making disclosures. This meansthat financial institutions may base their disclosures

on calculation tools that assume that all monthshave an equal number of days, even if theirpractice is to take account of the variations inmonths to collect interest. For example, an institution may calculate disclosures using a financialcalculator based on a 360-day year with 30-daymonths when, in fact, it collects interest by applyinga factor of 1365 of the annual interest rate to actualdays.

Disclosure violations may occur, however, whena financial institution applies a daily interest factorbased on a 360-day year to the actual number ofdays between payments. In those situations, the

institution must disclose the higher values of thefinance charge, the APR, and the payment schedule resulting from this practice. For example, a12 percent simple interest rate divided by 360 daysresults in a daily rate of .033333 percent. If nocharges are imposed except interest and theamount financed is the same as the loan amount,applying the daily rate on a daily basis for a365-day year on a $10,000 one-year, single-payment, unsecured loan results in an APR of12.17 percent (.033333 365 = 12.17) and afinance charge of $1,216.67. There would be aviolation if the APR were disclosed as 12 percent orthe finance charge were disclosed as $1,200 (12%

$10,000). However, if no other charges exceptinterest are imposed, the application of a 360-dayyear daily rate over 365 days on a regular loanwould not result in an APR in excess of theone-eighth of 1 percentage point APR toleranceunless the nominal interest rate is greater than9 percent. For irregular loans, with one-quarter of1 percentage point APR tolerance, the nominalinterest rate would have to be greater than18 percent to exceed the tolerance.

Variable-Rate Loans ( 226.18(f))

If the terms of the legal obligation allow the financialinstitution, after consummation of the transaction, toincrease the APR, the financial institution mustfurnish the consumer with certain information onvariable rates. Graduated-payment mortgages andstep-rate transactions without a variable-rate feature are not considered variable-rate transactions.In addition, variable-rate disclosures are not applicable to rate increases resulting from delinquency,default, assumption, acceleration, or transfer of thecollateral. Some of the more important transaction


specific variable-rate disclosure requirements undersection 226.18 follow:

Disclosures for variable-rate loans must coverthe full term of the transaction and must bebased on the terms in effect at the time ofconsummation.

If the variable-rate transaction includes either aseller buydown that is reflected in a contract or aconsumer buydown, the disclosed APR shouldbe a composite rate based on the lower rate forthe buydown period and the rate that is the basisfor the variable-rate feature for the remainder ofthe term.

If the initial rate is not determined by the index orformula used to make later interest rate adjustments, as in a discounted variable-rate transaction, the disclosed APR must reflect a compositerate based on the initial rate for as long as it isapplied and, for the remainder of the term, therate that would have been applied using theindex or formula at the time of consummation(that is, the fully indexed rate).

If a loan contains a rate or payment cap thatwould prevent the initial rate or payment, at thetime of the adjustment, from changing to thefully indexed rate, the effect of that rate orpayment cap needs to be reflected in thedisclosure.

The index at consummation need not be usedif the contract provides for a delay in implementation of changes in an index value (forexample, the contract indicates that futurerate changes are based on the index value

in effect for some specified period, suchas forty-five days before the change date).Instead, the financial institution may use anyrate from the date of consummation back tothe beginning of the specified period (forexample, during the previous forty-five-dayperiod).

If the initial interest rate is set according to theindex or formula used for later adjustments but isset at a value as of a date before consummation,disclosures should be based on the initialinterest rate, even though the index may havechanged by the consummation date.

For variable-rate consumer loans that are notsecured by the consumers principal dwelling orthat are secured by the consumers principaldwelling but have a term of one year or less,creditors must disclose the circumstances underwhich the rate may increase, any limitations on theincrease, the effect of an increase, and an exampleof the payment terms that would result from anincrease (section 226.18(f)(1)).

For variable-rate consumer loans that aresecuredby the consumers principal dwelling and have a
http:///reader/full/$1,216.67http:///reader/full/$1,216.67


19/37

Truth in Lending

maturity of more than one year, creditors must statethat the loan has a variable-rate feature and thatdisclosures were previously given (section226.18(f)(2)). Extensive disclosures about the loanprogram must be provided when consumers applyfor such a loan (section 226.19(b)) and throughoutthe loan term when the rate or payment amount is

changed (section 226.20(c)).

Payment Schedule ( 226.18(g))

The disclosed payment schedule must reflect allcomponents of the finance charge, including allscheduled payments to repay loan principal,interest on the loan, and any other finance chargepayable by the consumer after consummation ofthe transaction. Any finance charge paid separately before or at consummation (for example, odddays interest) is not to be treated as part of thepayment schedule; it is a prepaid finance charge

and must be reflected as a reduction in the value ofthe amount financed.

At the creditors option, the payment schedulemay include amounts beyond the amount financedand the finance charge (for example, certaininsurance premiums or real estate escrow amounts,such as taxes added to payments). However, thecreditor must disregard such amounts when calculating the APR.

If the obligation is a renewable balloon-paymentinstrument that unconditionally obligates the financial institution to renew the short-term loan at theconsumers option or to renew the loan subject to

conditions within the consumers control, the payment schedule must be disclosed using the longerterm of the renewal period or periods. The variable-rate feature for the long-term loan must bedisclosed.

If the instrument has no renewal conditions or thefinancial institution guarantees to renew the obligation in a refinancing, the payment schedule mustbe disclosed using the shorter balloon-paymentterm. The short-term loan must be disclosed as afixed-rate loan, unless it contains a variable-ratefeature during the initial loan term.

Amount Financed ( 226.18(b))

DefinitionThe amount financed is the net amount of creditextended for the consumers use. It should not beassumed that under the regulation, the amountfinanced is equivalent to the note amount, theproceeds, or the principal amount of the loan. Theamount financed normally equals the total ofpayments less the finance charge.


To calculate the amount financed, all amountsand charges connected with the transaction, eitherpaid separately or included in the note amount,must first be identified. Any prepaid, precomputed,or other finance charge must then be determined.

The amount financed must not include anyfinance

charges.

If finance charges have beenincluded in the obligation (either prepaid or pre

computed), they must be subtracted from the faceamount of the obligation when determining theamount financed. The resulting value must bereduced further by an amount equal to any prepaidfinance charge paid separately. The final resultingvalue is the amount financed.

When calculating the amount financed, financecharges (whether in the note amount or paidseparately) should not be subtracted more thanonce from the total amount of an obligation.Charges not in the note amount and not included inthe finance charge (for example, an appraisal fee

paid separately, in cash, on a real estate loan) neednot be disclosed under Regulation Z and must notbe included in the amount financed.

In a multiple-advance construction loan, proceeds placed in a temporary escrow account andawaiting disbursement to the developer in drawsare not considered part of the amount financed untilthey are actually disbursed. Thus, if the entirecommitment amount is disbursed into the lendersescrow account, the lender must not base disclosures on the assumption that all funds weredisbursed immediately, even if the lender paysinterest on the escrowed funds.

RequiredDeposit(226.18(r))A requireddeposit,with certain exceptions, is onethat the financial institution requires the consumerto maintain as a condition of the specific credittransaction. It can include a compensating balanceor a deposit balance that secures the loan. Theeffect of a required deposit is not reflected in theAPR. Also, a required deposit is not a financecharge, as it is eventually released to the consumer. A deposit that earns at least 5 percent peryear need not be considered a required deposit.

CalculatingtheAmountFinancedSuppose that a consumer signs a note secured byreal property in the amount of $5,435. The noteamount includes $5,000 in proceeds disbursed tothe consumer, $400 in precomputed interest, $25paid to a credit-reporting agency for a credit report,and a $10 service charge. Additionally, the consumer pays a $50 loan fee separately, in cash, atconsummation. The consumer has no other debt


20/37

Truth in Lending

with the financial institution. The amount financed is$4,975.

The amount financed may be calculated by firstsubtracting all finance charges included in the noteamount ($5,435 $400 $10 = $5,025). The $25credit-report fee is not a finance charge because

the loan is secured by real property. The $5,025 isfurther reduced by the amount of prepaid financecharges paid separately, for an amount financed of$5,025 $50 = $4,975. The answer is the samewhether finance charges included in the obligationare considered prepaid or precomputed financecharges.

The financial institution may treat the $10 servicecharge as an addition to the loan amount and notas a prepaid finance charge. If it does, the loanprincipal would be $5,000. The $5,000 loan principal does not include either the $400 or the $10precomputed finance charge in the note. The loanprincipal is increased by other amounts financed

that are not part of the finance charge (the $25credit-report fee) and reduced by any prepaidfinance charges (the $50 loan fee, but not the $10service charge) to arrive at the amount financed of$5,000 + $25 $50 = $4,975.

OtherCalculationsIn the preceding example, the financial institutionmay treat the $10 service charge as a prepaidfinance charge. If it does, the loan principal wouldbe $5,010. The $5,010 loan principal does notinclude the $400 precomputed finance charge. The

loan principal is increased by other amountsfinanced that are not part of the finance charge (the$25 credit-report fee) and reduced by any prepaid finance charges (the $50 loan fee and the$10 service charge withheld from the loan proceeds) to arrive at the same amount financed of$5,010 + $25 $50 $10 = $4,975.

Refinancings ( 226.20)

When an obligation is satisfied and replaced by anew obligation to the original financial institution (ora holder or servicer of the original obligation) and is

undertaken by the same consumer, it must betreated as a refinancing for which a complete set ofnew disclosures must be furnished. A refinancingmay involve the consolidation of several existingobligations, disbursement of new money to theconsumer, or the rescheduling of payments underan existing obligation. In any form, the newobligation must completely replace the earlier oneto be considered a refinancing under Regulation Z.The finance charge on the new disclosure mustinclude any unearned portion of the old finance


charge that is not credited to the existing obligation(section 226.20(a)).

The following transactions are not consideredrefinancings even if the existing obligation hasbeen satisfied and replaced by a new obligationundertaken by the same consumer:

A renewal of an obligation with a single paymentof principal and interest or with periodic interestpayments and a final payment of principal withno change in the original terms

An APR reduction with a corresponding changein the payment schedule

An agreement involving a court proceeding

Changes in credit terms arising from the consumers default or delinquency

The renewal of optional insurance purchased bythe consumer and added to an existing transaction, if required disclosures were provided for theinitial purchase of the insurance

However, even if it is not accomplished by thecancellation of the old obligation and substitution ofa new one, a new transaction subject to newdisclosures results if the financial institution doeseither of the following:

Increases the rate based on a variable-ratefeature that was not previously disclosed

Adds a variable-rate feature to the obligation

If the rate is increased at the time a loan is renewed,the increase is not considered a variable-ratefeature. It is the cost of renewal, similar to a flat fee,as long as the new rate remains fixed during the

remaining life of the loan. If the original debt is notcanceled in connection with such a renewal, newdisclosures are not required. Also, changing theindex of a variable-rate transaction to a comparable index is not considered adding a variable-rate feature to the obligation.

Miscellaneous Provisions (Subpart D)

Civil Liability (TILA 130)

If a creditor fails to comply with any requirements ofthe TILA, other than with the advertising provisionsof chapter 3, it may be held liable to the consumerfor both

Actual damage

The cost of any legal action together withreasonable attorneys fees in a successful action

If the creditor violates certain requirements of theTILA, it may also be held liable for either of thefollowing:

In an individual action, twice the amount of thefinance charge involved, but not less than $100


21/37

Truth in Lending

or more than $1,000. However, in an individualaction relating to a closed-end credit transactionsecured by real property or a dwelling, twice theamount of the finance charge involved, but notless than $200 or more than $2,000.

In a class action, such amount as the court mayallow. However, the total amount of recovery maynot be more than $500,000 or 1 percent of thecreditors net worth, whichever is less.

Civil actions that may be brought against acreditor may also be maintained against anyassignee of the creditor if the violation is apparenton the face of the disclosure statement or otherdocuments assigned, except when the assignmentwas involuntary.

A creditor that fails to comply with the TILAsrequirements for high-cost mortgage loans may beheld liable to the consumer for all finance chargesand fees paid to the creditor. Any subsequentassignee is subject to all claims and defenses thatthe consumer could assert against the creditor,unless the assignee demonstrates that it could notreasonably have determined that the loan wassubject to section 226.32 of Regulation Z.

Criminal Liability (TILA 112)

Anyone who willingly and knowingly fails to complywith any requirement of the TILA will be fined notmore than $5,000 or imprisoned not more than oneyear, or both.

Administrative Actions (TILA 108)The TILA authorizes federal regulatory agencies torequire financial institutions to make monetary andother adjustments to a consumers account whenthe true finance charge or APR exceeds thedisclosed finance charge or APR by more than aspecified accuracy tolerance. That authorizationextends to unintentional errors, including isolatedviolations (for example, an error that occurred onlyonce or errors, often without a common cause, thatoccurred infrequently and randomly).

Under certain circumstances, the TILA requiresfederal regulatory agencies to order financial

institutions to reimburse consumers when understatement of the APR or finance charge involves

Patterns or practices of violations (for example,errors that occurred, often with a common cause,consistently or frequently, reflecting a pattern inrelation to a specific type or types of consumercredit)

Gross negligence

Willful noncompliance intended to mislead theperson to whom the credit was extended


Any proceeding that may be brought by aregulatory agency against a creditor may bemaintained against any assignee of the creditorif the violation is apparent on the face of thedisclosure statement or other documents assigned,except when the assignment was involuntary (TILAsection 131).

Federal Reserve examiners follow the FFIECsinteragency Regulation Z policy guide when determining the applicability and amount of any reimbursements. Although the policy guide appears torequire reimbursement only in cases in which apattern or practice was discovered, System policyrequires banks to make reimbursements whenisolated cases are discovered as well. Unlike thediscovery of a pattern or practice of violations,which requires the bank to conduct a file search todetermine the extent of the pattern or practice, thediscovery of an isolated instance does not require afile search. Isolated violations are technical and

nonsubstantive in nature, are not cited in theexamination report, and may be communicated inan informal manner.

Relationship to State Law (TILA 111)

State laws providing rights, responsibilities, orprocedures for consumers or financial institutionsfor consumer credit contracts may be

Preempted by federal law

Appropriate under state law and not preemptedby federal law

Substituted in lieu of TILA and Regulation Zrequirements

State law provisions are preempted to the extentthat they contradict the requirements in the following chapters of the TILA and the implementingsections of Regulation Z:

Chapter 1, General Provisions, which containsdefinitions and acceptable methods for determining finance charges and annual percentagerates. For example, a state law would bepreempted if it required a bank to include in thefinance charge any fees that the federal lawexcludes, such as sellers points.

Chapter 2, Credit Transactions, which containsdisclosure requirements, rescission rights, andcertain credit card provisions. For example, astate law would be preempted if it required abank to use the term nominal annual interestrate in lieu of annual percentage rate.

Chapter 3, Credit Advertising, which containsrules for consumer credit advertising and requirements for the oral disclosure of annual percentage rates.


22/37

Truth in Lending

Conversely, state law provisions may be appropriate and are not preempted under federal law ifthey call for, without contradicting chapters 1, 2, or3 of the TILA or the implementing sections ofRegulation Z, either of the following:

Disclosure of information not otherwise required.

A state law that requires disclosure of theminimum periodic payment for open-end credit,for example, would not be preempted because itdoes not contradict federal law.

Disclosures more detailed than those required. Astate law that requires itemization of the amountfinanced, for example, would not be preempted,unless it contradicts federal law by requiring theitemization to appear with the disclosure of theamount financed in the segregated closed-endcredit disclosures.

Two preemption standards apply to TILA chapter 4. One applies to section 161 (Correction of

Billing Errors) and 162 (Regulation of CreditReports), the other to the remaining provisions ofchapter 4 (sections 163171).

State law provisions are preempted if they differfrom the rights, responsibilities, or procedurescontained in section 161 or 162 of the TILA. Anexception is made, however, for state law thatallows a consumer to inquire about an account andrequires the bank to respond to such inquirybeyond the time limits provided by federal law.Such a state law would not be preempted for theextra time period.

State law provisions are preempted if they result

in violations of sections 163 through 171 ofchapter 4 of the TILA. For example, a state law thatallows the card issuer to offset the consumerscredit card indebtedness against funds held by thecard issuer would be preempted, as it would violatesection 226.12(d) of Regulation Z. Conversely, astate law that requires periodic statements to besent more than fourteen days before the end of afree-ride period would not be preempted, as noviolation of federal law is involved.

A bank, state, or other interested party may askthe Federal Reserve Board to determine whetherstate law contradicts chapters 1 through 3 of theTILA or Regulation Z. They may also ask if the state

law is different from, or would result in violations of,chapter 4 of the TILA and the implementingprovisions of Regulation Z. If the Board determinesthat a disclosure required by state law (other than arequirement relating to the finance charge, theannual percentage rate, or the disclosures requiredunder section 226.32 of the regulation) is substantially the same in meaning as a disclosure requiredunder the act or the regulation, generally, creditorsin that state may make the state disclosure in lieu ofthe federal disclosure.


Special Rules for Certain HomeMortgage Transactions (Subpart E)

General Rules ( 226.31)

The requirements and limitations of subpart E are inaddition to and not in lieu of those contained inother subparts of Regulation Z. The disclosures forhigh-cost and reverse mortgage transactions mustbe made clearly and conspicuously in writing, in aform that the consumer can keep.

Certain Closed-End Home Mortgages( 226.32)

The requirements of section 226.32 apply to aconsumer credit transaction secured by the consumers principal dwelling in which either

The APR at consummation will exceed by more

than 8 percentage points for first-lien mortgageloans, or by more than 10 percentage points forsubordinate-lien mortgage loans, the yield onTreasury securities having periods of maturitycomparable to the loans maturity (as of the 15thday of the month immediately preceding themonth in which the application for the extensionof credit is received by the creditor)

The total points and fees (see definition below)payable by the consumer at or before loanclosing will exceed the greater of 8 percent of thetotal loan amount or a dollar amount that isadjusted annually on the basis of changes in theconsumer price index (See staff commentary to

section 226.32(a)(1)(ii) of Regulation Z for ahistorical list of dollar amount adjustments. Forcalendar year 2005, the dollar amount was$510.) (section 226.32(a)(1))

ExemptionsThe following are exempt from section 226.32:

Residential mortgage transactions (generally,purchase money mortgages)

Reverse mortgage transactions subject to section 226.33 of Regulation Z

Open-end credit plans subject to subpart B ofthe regulation

PointsandFeesPoints and fees include the following:

All items required to be disclosed under sections226.4(a) and (b) of Regulation Z except interestor the timeprice differential

All compensation paid to mortgage brokers


23/37

Truth in Lending

All items listed in section 226.4(c)(7) other thanamounts held for future taxes, unless all of thefollowingconditionsaremet: The charge is reasonable

The creditor receives no direct or indirectcompensation in connection with the charge

The charge is not paid to an affiliate of thecreditor

Premiums or other charges, paid at or beforeclosing whether paid in cash or financed, foroptional credit life, accident, health, or loss-ofincome insurance, and other debt-protection ordebt-cancellation products written in connectionwith the credit transaction (section 226.32(b)(1))

Reverse Mortgages ( 226.33)

A reversemortgage is a non-recourse transactionsecured by the consumers principal dwelling thatties repayment (other than upon default) to thehomeowners death or permanent move from, ortransfer of the title of, the home.

Specific DefensesTILA Section 108

Defense against Civil, Criminal, andAdministrative Actions

A financial institution in violation of the TILA mayavoid liability by doing all of the following:

Discovering the error before an action is broughtagainst the institution, or before the consumernotifies the institution, in writing, of the error

Notifying the consumer of the error within sixtydays of discovery

Making the necessary adjustments to the consumers account, also within sixty days ofdiscovery (The consumer will pay no more thanthe lesser of the finance charge actually disclosed or the dollar equivalent of the APRactually disclosed.)

Taking these three actions may also allow thefinancial institution to avoid a regulatory order toreimburse the customer.

An error is discovered if it is

Discussed in a final, written report of examination

Identified through the financial institutions ownprocedures

An inaccurately disclosed APR or finance chargeincluded in a regulatory agency notification tothe financial institution

When a disclosure error occurs, the financialinstitution is not required to re-disclose after a loanhas been consummated or an account has beenopened. If the institution corrects a disclosure error

by merely re-disclosing required information accurately, without adjusting the consumers account,the financial institution may still be subject to civilliability and an order from its regulator to reimburse.

The circumstances under which a financialinstitution may avoid liability under the TILA do not

apply to violations of the Fair Credit Billing Act(chapter 4 of the TILA).

Additional Defenses against Civil Actions

A financial institution may avoid liability in a civilaction if it shows, by a preponderance of evidence,that the violation was not intentional and resultedfrom a bona fide error that occurred despite themaintenance of procedures to avoid the error.

A bona fide error may be a clerical, calculation,programming, or printing error or a computermalfunction. It does not include an error of legaljudgment.

Showing that a violation occurred unintentionallycould be difficult if the financial institution is unableto produce evidence that explicitly indicates that ithas an internal controls program designed toensure compliance. The financial institutions demonstrated commitment to compliance and its adoption of policies and procedures to detect errorsbefore disclosures are furnished to consumerscould strengthen its defense.

Statute of LimitationsTILA Sections 108 and 130

Civil actions may be brought within one year afterthe violation occurred. After that time, and ifallowed by state law, the consumer may still assertthe violation as a defense if a financial institutionbrings an action to collect the consumers debt.Criminal actions are not subject to the TILAone-year statute of limitations.

Regulatory administrative enforcement actionsalso are not subject to the one-year statute oflimitations. However, enforcement actions underthe FFIEC policy guide involving erroneously disclosed APRs and finance charges are subject totime limitations by the TILA. Those limitations range

from the date of the most recent regulatoryexamination of the financial institution to as far backas 1969, depending on when the loan was made,when the violation was identified, whether theviolation was a repeat violation, and other factors.

There is no time limitation on willful violationsintended to mislead the consumer. The followingsummarize the various time limitations:

For open-end credit, reimbursement applies toviolations not older than two years.



24/37

Truth in Lending

For closed-end credit, reimbursement is generally applied to loans with violations occurringsince the immediately preceding examination.

Rescission Rights (Open-Endand Closed-End Credit)

Sections 226.15 and 226.23

The TILA provides that for certain transactionssecured by a consumers principal dwelling, theconsumer has three business days after becomingobligated on the debt to rescind the transaction.The right of rescission allows the consumer time toreexamine the credit agreement and cost disclosures and to reconsider whether he or she wants toplace his or her hom

Documents

TILA Supplemental Manual