Understanding the Impact of State Laws and Their Connection to Annual Percentage Rate Caps

Well, it is the Carleton Compliance Team's favorite time of the year! Legislatures are back in full swing, and new bills have popped up potentially affecting consumer credit all over the country. Colorado, Connecticut, Indiana, Oklahoma, South Carolina (among others)—all have legislation that has been introduced or pre-filed which contain a new rate cap determining what lenders can charge for making small loans. 

While we joke about new laws affecting the consumer credit industry, we recognize these laws have significant impacts on our industry. One point that rarely gets addressed when these types of new bills are debated is the ramification for a lender of mistakenly tying a state's rate caps to a Truth in Lending Act (“TILA”) Annual Percentage Rate (“APR”). In the rush to draft new rate caps or to interpret the legislation, key concepts quickly get overlooked. And basic consumer math criteria get conflated.

So, what does it mean when a state ties its lending laws to the Truth in Lending Act? 

That's right. It gets complicated! As we field more and more compliance-related questions, we are always a bit surprised that the “Maximum APR” viewpoint is still so prevalent in the consumer finance industry (“All-in” rate caps aside).

The fact is, most consumer lending statutes continue to regulate the dollar amount of the charge, whether it's referred to as interest, finance charge, or time-price differential. The dollar charge is created by applying the published maximum rate to the outstanding balances of the transaction. How that rate is applied is key.

The Truth in Lending Act's Actuarial Method was created to “level the playing field” when computing an APR for comparison sake. To achieve that goal, TILA proscribes the use of the Federal Calendar and disregards how a specific creditor actually computes dollar interest charges. How? By the use of a calendar which is periodic in nature--the Federal Calendar. 

In contrast, in many cases, the state-prescribed calendar for determining the maximum charge differs from the one used to compute the TILA APR. In such an instance, the APR is not necessarily an accurate barometer of compliance with a state statutory provision or the maximum charge allowed. 

Furthermore, in today's context, you have to assess the effect of “simple interest”, which often corresponds to daily charge accrual. Many statutes are rather antiquated and originally constructed in a time when daily interest was not the norm. Rate caps may have been updated, but other code provisions written in a time where periodic calculations were the norm may have been left behind.

Another complicating factor is that by necessity the TILA APR is generally disclosed as a two or three place decimal value. The rate has to fit in the “Fed Box”, which means it is a rounded value. Quite often the TILA APR, rounded for the purpose of display, can provide a false sense of compliance. Applying that rounded rate can, in certain conditions, produce an overcharge for specific loans using the state's prescribed requirements. 

So, is it possible for a transaction with a disclosed 21% TILA APR to also exceed a 21% statutory maximum rate applied on a daily basis and thus represent a potential violation? 

Yes! The devil is in the details! In conclusion, be wary of new state laws that appear to be tied to an “APR” cap. 

Fortunately, Carleton's compliance team specializes in monitoring federal and state regulation changes across all 50 states.  With over 75 combined years of experience among our staff attorneys and compliance personnel, we help provide our clients that peace of mind knowing our solutions and services have compliance embedded.

To learn more about Carleton's compliance services, click here or contact us directly.

*This article was updated from the original thought leadership blog “Maximum Finance Charges...It's Not Just the Rate”