Last summer, the U.S. Congress enacted the Higher Education Opportunity Act of 2008, which included the Private Student Loan Transparency and Improvement Act of 2008 (the “Act”). In addition to amending the Higher Education Act of 1965 to cover private student loans for the first time, the Act amended the Truth in Lending Act to expand the scope of required disclosures for private student loans from application through loan approval and consummation. The Act also removes the dollar limit that applies to all other non-mortgage loans, expressly making TILA applicable to private student loans in amounts that exceed $25,000. As a result, private student loans are arguably more closely regulated than their federally insured or guaranteed counterparts.
On March 24, 2009, the Federal Reserve Board proposed rules amending TILA to implement the disclosure and other requirements of the Act. If the Fed makes the rule final as written, lenders who make private student loans will have to dramatically alter their loan application and fulfillment processes, because they will need new loan documents and programming to accommodate the revised structure of the new required disclosures.
Under the Act, lenders making private student loans will have to provide borrowers with new disclosures at three intervals: (1) at application, or in solicitations where no application is required, (2) at approval, and (3) at consummation. The Act also gives potential private student loan borrowers 30 days after loan approval to decide whether to accept the loan on the terms offered, as well as a right to cancel or rescind the loan for three days following consummation and other substantive rights. As is the case under TILA with non-purchase money mortgage loans secured by a principal residence, the lender making a private student loan subject to the proposed rules may not disburse funds until the rescission period has run.
The proposed rule provides guidance for complying with the new disclosure requirements, and also promulgates model forms that will appear with other Regulation Z closed-end credit model forms. Briefly, the new disclosures are:
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Application/Solicitation Disclosure - Applications and solicitations for credit where no application is required must include information about rates, fees and terms, including an example of the total cost of the loan based on the maximum interest rate the creditor may charge. The lender must also disclose information about federal loans that may be available as an alternative to the private loan, including the interest rates on those federal loans and information about how to obtain more information about federal loans.
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Loan Approval Disclosure - Lenders have to give transaction-specific information in a loan approval disclosure. The disclosure must include, among other things, the applicable interest rate, the fees the borrower can expect to pay, and the terms specific to the loan for which the borrower was approved. The lender also has to remind the borrower if there are federal loan alternatives to the loan for which the borrower has been approved and suggest that the borrower consult with the school or the federal Department of Education about those alternatives. Finally, the lender must disclose what the monthly payment would be at the maximum possible rate of interest.
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Final Disclosure - At consummation, the lender must provide updated cost disclosures in a form that closely resembles the loan approval disclosures, and must also disclose the borrower’s three-day right to cancel the transaction in a form only slightly less conspicuous than the required finance charge and other numeric disclosures.
Some aspects of the potential new disclosures are particularly worthy of mention. First, the Fed proposes to require a “most conspicuous” disclosure of the applicable periodic interest rate in the Loan Approval and Final Disclosure, moving away from what has become the long-standing TILA requirement that the Annual Percentage Rate be the most conspicuous of the required disclosures along with the Finance Charge. The Fed commissioned some consumer research about what information college students and their parents found most compelling among the cost disclosures before proposing this rule. In a result that should really surprise no one, the researchers found that the students and their parents were confused by the APR disclosure and found the periodic rate disclosure to be the more meaningful number. The fact that the periodic interest rate and the APR were different “impair[ed] the consumers’ understanding of the rate that applies to the private education loan,” and the consumers indicated that “the interest rate is most relevant to them for private education loan purposes.” Something tells us that if the Fed expanded this research to include consumers of other kinds of credit, they’d get a similar result. The APR is still a required segregated disclosure, but it will not have to be “more conspicuous” than the other required disclosures.
The model forms proposed for use with private student loans do not look much like the other closed-end credit model forms. The primary differences are (1) the “Interest Rate” disclosure box that replaces the APR disclosure among the prominent numeric disclosures, (2) the required inclusion of the Itemization of Amount Financed among the segregated required disclosures, and (3) an itemized disclosure of “other” fees the borrower may have to pay, including the application fee, loan origination fee, late charge and returned check charge. Unlike the other closed-end credit model forms, the model form also includes a table showing the payment schedule using the actual applicable interest rate along side a payment schedule that assumes the maximum possible rate of interest will apply. And, pursuant to proposed Official Staff Commentary, the disclosure of the right to cancel in the Final Disclosure has to be “more conspicuous” than any other required disclosure except the interest rate, finance charge and the creditor’s identity.
In all, lenders will have to develop new loan disclosure forms with substantially more information in them to comply with these requirements. Gone may be the days when a student loan note and disclosure form were substantially the same as the forms a bank or other lender used in its other direct consumer lending programs. If this rule survives in its proposed form, lenders will not even be able to document federal loans on the same forms it uses for private student loans.
The Comment period for this proposed rule ends on May 26, 2009, and the Fed is scheduled to issue its final rule by August 14, 2009. The full text of the proposed rule can be found at 74 Fed. Reg. 12464.
Chuck Dodge is a partner in the Maryland office of Hudson Cook, LLP. Basis Points readers can reach Chuck at 410-865-5427 or by email at cdodge@hudco.com.
Maya Hill is an associate in the Maryland office of Hudson Cook, LLP. Basis Points readers can reach Maya at 410-782-2356 or by email at mhill@hudco.com.