What it means
Consumer loans have sometimes included contract terms that are heavily one-sided. Regulation AA, through its Credit Practices Rule, defines some of them as unfair or deceptive acts and prohibits them in consumer credit contracts.
The rule applies to banks and their subsidiaries, each bank's own federal regulator enforces it, and other agencies have matching rules for other types of lender. The prohibited practices are specific.
They include a confession of judgment, where the borrower agrees in advance to let the lender win a court case without a hearing, and a waiver of exemption, where the borrower gives up legal protections for certain property. They also cover certain wage assignments, which let a lender take pay directly from an employer, and claims over household goods when the loan was not used to buy them.
Two further protections concern cosigners and fees. A lender may not misrepresent a cosigner's liability, and must give a clear notice explaining it before the cosigner becomes bound.
The rule also bans pyramiding late charges, which means charging a late fee on a payment that was made on time simply because an earlier late fee was left unpaid. The first part of the regulation deals with complaints.
It sets out how consumers can bring complaints about state-chartered banks that are members of the Federal Reserve System, and how those complaints are to be handled. This gives customers a route to be heard when they believe a bank has treated them unfairly.
For a business, the rule matters most to lenders and to companies that offer credit to consumers, such as retailers with store finance. Contract templates should be reviewed to be sure they do not contain prohibited terms.
Rules on consumer credit have been shared between agencies over time, so the right regulator and rule text should be confirmed with counsel. For other finance staff, the lesson is practical.
A clause that is common in older contracts, or copied from another jurisdiction, can be unlawful in consumer lending. A periodic review of standard documents is a low-cost way of avoiding complaints, penalties and damaged reputation, and it should involve legal, compliance and finance staff together.
In practice
Real-world examples.
Example
A bank reviews its personal loan agreement and finds a clause that lets it take part of the borrower's wages directly from the employer without a court order. Compliance staff delete the clause because the Credit Practices Rule treats it as unfair.
Example
A furniture retailer offers store credit and takes a security interest in the customer's other household goods to cover the loan. Its adviser explains that, for a loan not used to buy those goods, this kind of claim is prohibited, so the retailer changes its contract.
Example
A parent is asked to cosign her daughter's car loan. The lender must give her a clear written notice explaining that she can be held fully responsible for the debt, so she understands the risk before she signs. The notice must be clear enough that an ordinary reader can see she may have to pay the whole amount.
Case study
Seen in the real world.
Cardinal Lane Credit is an illustrative, fictional lender that expanded into small personal loans. Its loan agreement had been copied from a template used in another business, and it included a late fee on any payment made while an earlier late fee remained unpaid.
A compliance review found that the clause pyramided late charges, which the Credit Practices Rule prohibits. On a typical loan with a $25 late fee, a customer who missed one payment and then paid every later instalment on time could be charged $25 again each month for the old fee alone.
The company rewrote its contract, refunded the extra fees it had collected, which came to about $38,000, and set up an annual legal review of its templates. The illustrative lesson is that borrowed contract language can carry hidden compliance risk.
Watch out
Common mistakes.
- Copying a loan template from another jurisdiction or business without checking it against consumer credit rules.
- Charging a late fee on a timely payment because an earlier late fee is still outstanding.
- Failing to give cosigners a clear notice about their liability before they sign.
Questions
People also ask.
What does Regulation AA cover?
It covers a procedure for consumer complaints about certain banks and the Credit Practices Rule, which bans unfair terms in consumer credit contracts.
What is pyramiding of late charges?
It is charging a late fee on an on-time payment because a previous late fee has not been paid.
Who is affected by the rule?
Banks and lenders that offer consumer credit are affected, and the right regulator and rule text depend on the type of lender, so check with counsel. Companies that extend store credit should check too.
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