The next compliance consideration that all financial institutions should review relates to fair lending. The concern, of course, for fair lending is that all applicants are treated equally. For CD secured loans, this means that the application process and underwriting evaluation should be conducted in a consistent manner for all applicants.
One of the main fair lending concerns found during fair lending audits of CD secured loans relates to inconsistencies in pulling credit reports for these types of loans. As explained previously, CD secured and share loans are typically underwritten according to one factor: the collateral. This means that financial institutions often don’t really care about things like credit history or even income. The challenge, from a fair lending purpose, can result if a financial institution does not have well defined procedures which all employees must follow for CD secured loans.
For example, if lenders are arbitrary pulling credit reports for some applicants, but not doing so for others, this practice could result in comparative evidence of disparate impact. Even if there is no intention of discrimination, the courts recognize “comparative evidence” when a protected class is treated in an unfavorable way when compared to a control group applicant.
While Regulation Z has quite a few requirements for any loan, there is one issue in particular that is a common violation for CD and deposit secured loans. This violation relates to a requirement in Regulation Z where creditors must tell customers that the quoted annual percentage rate (APR) does not reflect the effect of the required deposit. In other words, the APR calculation does not include considerations for the cost of having the CD or any interest earned on the CD.
Specifically, section (r) of Regulation Z sets forth a requirement for a disclosure of “required deposit” to be included in the “Fed box” on the Truth-in-Lending disclosures (TIL) for any loan secured by a deposit. The rule states the following:
“If the creditor requires the consumer to maintain a deposit as a condition of the specific transaction, a statement that the annual percentage rate does not reflect the effect of the required deposit. A required deposit need not include, for example:
As you can see from this rule, there are a few exceptions to the requirement to provide the required deposit statement. First, an escrow account held as collateral does not require this disclosure. The same is true for a qualified Morris Plan. The other exception, found in 102618(r)(2) is a bit more complex. The way this rule works is that when a deposit earns at least 5 percent interest per year, no disclosure is required under §(r). This exception also applies whether the deposit is held by the creditor or by a third party.
Deposit accounts which earn less than 5% per year must have the disclosure, but those earning over 5% do not. Logistically speaking, this rule can make it very easy to have a violation if creditors don’t just provide the disclosure every time. When rates are either very low or very high, this rule doesn’t really have much of an effect. However, when some deposit rates exceed 5% and others don’t, the opportunity for the required deposit disclosure to be missed would greatly increase if a financial institution did not require the disclosure for every loan.
As the commentary makes it clear that the disclosure is permitted regardless of whether the disclosure is technically required, the best practice is to just provide the required deposit disclosure for every deposit secured loan. This is by far one of the most common violations found during reviews of CD and deposit secured loans.