Regulation Z Fine Print: Sample Form Required for Private Loan Applications

Included with the release of final rules by the Federal Reserve amending Regulation Z is the sample forms required for private loan applications and solicitations, loan approval and final approval. 

First, I will tackle the application and solicitation sample form.  Here are the key elements in this disclosure (see sample below):

• Differentiates between range of starting interest rates and interest rates during the life of the loan based on consumer research:

"...consumers were confused in the initial rounds by seeing the required disclosure of a range of initial rates for which they could be approved.  Consumers commonly mistook the highest rate in the range with the maximum possible rate for the life of the loan. Consequently, the model form was revised by providing information under two separate headings for the consumer’s “Starting interest rate upon approval” and the consumer’s “Interest rate during the life of the loan.” This revision improved consumers’ ability to understand the range of initial interest rates and how the
rate would vary over time."

• Does not incorporate A.P.R. into the disclosure.  Why?

"...the Board does not believe that making the APR less prominent is likely to cause consumers to focus solely on the interest rate to the exclusion of other costs. When consumers were asked in  testing to determine which of two sample loans was less expensive, they relied on information other than the interest rate and APR to make their determination, such as the finance charge or the total of payments. By using the other cost information all consumers tested were able to select the loan that had a lower APR, even when it had a higher interest rate.6" [6 Rockbridge Associates, “Consumer Research and Testing for Private Education Loans: Final Report of
Findings” at 55.]

• Highlights general factors that may impact the interest rate on the loan:

"Once consumers understood that the rates disclosed were not necessarily the rates
that actually would apply to them, they consistently wanted to know how their own rate
would be determined. Thus, the model form places general information about how the
consumer’s rate will be determined under the heading about the consumer’s starting
interest rate upon approval."

• Requires lenders to disclose maximum allowable interest rate (if applicable). 

• Requires disclosure of fees including application, origination, loan guarantee, repayment, late charges and returned check fee
  
  • Does NOT require disclosure of "fees for exercising deferment, forbearance, or
    loan modification options" nor did it require disclosure of "third-party fees and costs for collection- or default-related expenses that might be passed on to the consumer, as these are not easily predicted and may never apply."
  • SLA note:  With the late fees, it would have been nice to know how many days after the due date a payment would have been considered late.  As for deferment, forbearance or loan modification fees, I suspect that this lack of disclosure will harm consumers as lenders take advantage of these challenging times to levy these fees.  I am aware of one lender charging forbearance fees today...let's see how many do in twelve months.

• Includes a notice regarding private loan discharge limitations in bankruptcy:
  
  • Language is "If you file for bankruptcy, you may still be required to pay back the loan."
  • This represents a change from their original proposal and was highlighted by several consumer group commenters (including SLA).  

• For loan cost examples, the following assumptions will be held constant for all lenders:
  • $10,000 loan amount (unless they only offer a lower loan amount in which case they would use $5,000)
  • Calculates cost of the loan using the "higher initial rate of interest applicable to the loan and the fees applicable to loans at the highest initial rate of interest."
  • Estimate of loan costs should incorporate capitalization method that lender uses for the loan (if capitalized on quarterly basis then needs to calculate as such). 
  • Two methods for deferral period; neither allows for disclosures tailored to individual consumers:
    • Undergraduates:  4 years + grace period (if applicable); other loans:  2 years + grace period
    • If creditor knows that student will be in a program with standard duration, can assume that consumer defers payment for full duration of the program plus a grace period (if applicable):
      • Medical school example:  4 year period
  • SLA Comment:  Interestingly, there does not appear to be any guidance on what assumption lenders should use for loan term (number of years) in calculating loan cost.  This is a glaring omission on the part of regulators (if I am missing something, someone please let me know) and lead to suboptimal decisions by consumers.
    
    • Why?  Lenders that assume shorter payment terms will look more attractive using this sample form even if they have higher maximum interest rates since A.P.R. calculations do not appear anywhere on this form. 
      
      • Here is a an example:  Lender A has the highest maximum interest rates but the lowest standard loan term.  For borrowers who focus strictly on the total payments column (which many do based on the Fed research), Lender A may look quite attractive since their loan term is 10 years (or about 1/2 of the industry average making their payments that much lower)  However, selecting based on total payments is suboptimizing in this case.  Private loans have no prepayment penalties so borrowers can repay over any term that they choose (a notable omission on the disclosure form too).  Far better for a borrower to take a loan that has a lower interest rate and replicate this shorter term rather than take out a higher interest rate loan that "appears" to have lower total cost.  Well I guess there will continue to be a need for SLA's Private Student Loan Ratings after all. 

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Here is what I think about it.