No Good Deed Goes Unpunished

Here’s the idea: A bad credit customer who pays as agreed for a specified period gets a rate break. What could be fairer? Wouldn’t such a program make the regulators, including the Consumer Financial Protection Bureau (CFPB), smile?

The program would award subprime customers who meet their payment obligations with a “step down” to increasingly lower finance charge rates. As an example, a customer whose credit warranted an initial rate of 24 percent APR and who made his or her first six payments on time might see the APR drop to 22 percent. Six more timely payments and the rate might drop to 20 percent, then to 18 percent, and so on. We’ll call it the “Good Repayment Incentive Program,” or “GRIP.”

There’s a lot to like about a GRIP. Customers are rewarded with favorable rates for timely payment, and the program should deter the occasional refinancing that results when a customer’s credit rating improves and the customer is able to find a lower rate for his or her car financing. Such a program should also gain a public relations benefit for the company offering it. After all, what could be fairer than rewarding realworld payment performance? A good deed!

But, as the adage goes, no good deed goes unpunished, and this one’s no different. The punishment, in this case, comes from a combination of the federal Truth in Lending Act (TILA) and state and federal prohibitions against unfair and deceptive acts and practices (UDAP). I would be concerned that no matter how well-intentioned, a GRIP’s structure might leave it vulnerable to attack.

My concerns arise from the treatment such a program would receive under the TILA and the potential for allegations of creditor abuse that might arise from that treatment. Under the TILA, federal disclosures are based on the contract between the parties, and creditors are permitted to make the assumption that the obligor will make all of his or her payments on time. In a GRIP, a creditor would assume that the customer would make every payment on time, and would disclose not a 24 percent APR, but a “blended” APR that would reflect the drop in the APR rate over time due to the assumed timely payments. That disclosure would be accurate for the customer who actually paid on time and qualified for progressively lower rates, but not, in retrospect, for the customer who doesn’t.

I believe this method of disclosure would be perfectly acceptable under federal dis- closure laws, but I shudder to think about how regulators and consumer interest groups would react. These folks would imme- diately spot the possibility for abuse in such a program.

A creditor offering such a program would make the TILA disclosures correctly, showing a blended rate reflecting the contractual agreement between the parties. The fly in the soup, though, is that, perhaps, only a small percentage of customers — those who actually made every payment on time — would ultimately end up paying the disclosed blended rate. If you assume that a significant number of subprime customers will be late now and again, then the lower, disclosed rate could be argued to be illusory, perhaps even fraudulent, or a violation of state UDAP laws.

Is there a way to fix these problems and save a program that would so obviously benefit consumers? Perhaps, but the fix would not be an easy one.

A creditor offering such a program would make the TILA disclosures correctly, showing a blended rate reflecting the 

One approach would be to change TILA and Reg. Z to specifically provide for these programs. Perhaps the consumer could be given two disclosure statements — one showing the application of the original APR and the other disclosing the blended APR. If the regulator could be persuaded that the creditor was willing to make prominent disclosures alerting the customer that the disclosed rates would apply only to perfect payment records, the regulator just might back a GRIP. Sadly, amendments like these take a long time to put in place.

The potential issues with such a program are not limited to the federal disclosure rules and potential state and federal UDAP claims. There might be other state law problems, as well.

Your state might prohibit varying rates or treat the fail- ure to step down the rate as a prohibited late or delinquency charge under state law. The rate reduction might be deemed to be a “refinancing” under state law requiring certain disclo- sures.

So perhaps you decide that the benefits outweigh the risks. Before you implement it, you need to have a good long talk with your friendly compliance lawyer and make sure you’ve done your homework before you get a GRIP.