Insights

Anyone who has children, or has spent any significant amount of time with them, knows that the little ones are always testing their limits. It’s all part of the natural biological/societal process of determining what is acceptable behavior or, put another way, figuring out what you can get away with. Parents are active participants in the process; they are, after all, the ones usually setting the limits. It’s just the natural order of things. And, if recent events are any indication, it may be the natural order of things over at the Consumer Financial Protection Bureau, as well.

On July 9, the CFPB issued a proposed rule that deals primarily with mortgage disclosures. Ordinarily, I would do little more than glance at a proposed mortgage rule, instead relying on my partners who are immersed in mortgage finance to determine the ins and outs of the proposal. However, this time, I had a pretty good hunch that the CFPB would test its limits with this proposal in a way that could have serious ramifications for the auto finance industry.

Buried in this 1,099-page proposal is a provision that would eliminate the long-standing finance charge exclusions for voluntarily purchased add-on products in certain closed-end mortgage transactions. In other words, charges for things like voluntary credit insurance and debt cancellation products, should the borrower choose to buy them, would be included in the finance charge calculation, thus increasing the APR. The rationale is that doing so would give the borrower a better understanding of the cost of a particular credit transaction. What’s dangerous about this proposal is that if the CFPB is successful in its attempt to implement this rule for mortgages, there is little reason for the Bureau not to apply it to other closed-end credit products, as well. For the auto finance industry, this could be disastrous.

There are so many things wrong with the CFPB’s proposal that there isn’t enough real estate in this publication to address them all. First off, the CFPB has exceeded its authority. The ability of a creditor to exclude certain voluntary costs from the finance charge is embedded in the Truth in Lending Act. While it is true that Congress gave the CFPB a great deal of latitude to implement the purpose of TILA, that latitude doesn’t extend to writing a rule that renders the statute ineffective. Federal agencies like the CFPB are charged with implementing statutes, not rewriting them.

Second, to include in the finance charge a product that is voluntarily purchased by a consumer makes little sense. Assume for a moment that a consumer bought a $500 credit insurance product the day after closing a vehicle finance transaction and financed the purchase through a bank. Under the CFPB’s rule (were it to be applied universally), the entire amount borrowed to pay for the product would be disclosed as a finance charge – the amount financed would be disclosed as “$0.00.” I’m no math whiz, but I know you can’t calculate a meaningful APR on a $0.00 amount financed. On the other hand, had the consumer purchased the product in the vehicle finance transaction, a 5% APR could suddenly become 9%, for no reason other than the consumer’s voluntary decision to purchase an additional product.

Third, had Congress intended to change the definition of APR or eliminate the finance charge exclusions in TILA, it could have done so when it revised TILA in the Dodd–Frank Act. It didn’t, and that should count for something.

This “all-in” APR concept, if applied to auto finance, would wreak all sorts of havoc. Dealer discretion in setting APRs would be impossible to police if a customer’s decision to purchase a credit insurance product could knock the APR up four or five points. DMS vendors would spend a fortune rewriting calculations and reprogramming dealers to take into account all the permutations a particular transaction might undergo. Finance company funding departments would experience a significantly longer intake process in order to ascertain the impact of voluntary products on finance company- or state law-imposed dealer compensation caps.

Maybe, most disturbingly, dealers in states that tie their usury caps to APRs would likely lose entire revenue streams since including a product that the customer voluntarily purchased in the APR could render the financing transaction usurious. What finance company would buy that paper? I’m not sure the CFPB even thought seriously about this.

The CFPB will naturally seek to test its limits in its rulemaking activities, as well as in its supervision and enforcement activities. I’m in favor of the Bureau garnering a clear understanding of what it can and cannot do – that’s just part of the process. Industry must balance the wisdom of a fight with the fact that it must live with its regulators for the long haul. However, pushing back and saying “no” can be an important part of that process. We all know at least one parent who never set those limits for his or her child, and we all know how that child turned out. In fact, we may work with some of them!

As Hillary said, “It takes a village” – for regulators and children alike.

Michael Benoit is a partner in the Washington, DC office of Hudson Cook, LLP. Michael can be reached at 202-327-9705 or by email at mbenoit@hudco.com.