Discounted Loan Rates to Customers with Products
Inquiry/Issue
The Bank would like to build a strong relationship with its customers. In order to encourage this, the Bank would like to start offering personal loans with discounted rates available for those customers with deposit accounts with the Bank. For example, the Bank would make a personal loan to a customer at a higher rate and then discount the rate if the customer had certain deposit accounts (e.g., Certificate of Deposit, Savings Account, etc.). The discount would last only as long as the customer had those accounts. Under the laws and regulations, is this permissible? What disclosures are required?
Response Summary
The Fair Lending rules would not prevent the Bank from making loans at a preferential rate, but in describing the product in its policy or procedures, it should indicate that it considered whether the product would have a disparate effect and concluded that it would not. The loan disclosures would generally follow those for variable rate loans, though the disclosures pertaining to ARMs would be more limited than for conventional ARMs.
Response Detail
There is nothing in the Equal Credit Opportunity Act, as implemented by Regulation B, or the Fair Housing Act (collectively, “Fair Lending”), which would prevent the Bank from making loans to customers with certain deposit accounts at a preferential, discounted rate.
A question would be whether such loans would in effect be made on a prohibited basis, which is to say, on a basis such as race, color, religion, national origin, sex, marital status, or age. To discriminate against an applicant means to treat one applicant less favorably than another. While the loan product itself may be silent as to such factors, the Federal regulators would look to any disparate effect the ostensible criteria have on protected groups. 12 CFR §1002.2(n), (z); Official Interpretations, ¶1002.4(a)-1; 42 U.S.C. 3604.
In adopting such a product, the memorandum of the Bank’s approval should indicate that it has considered Fair Lending requirements and found that the product would not have a disparate, discriminatory effect, that the class of applicants would be drawn from the customers of the Bank who were not limited on any basis that would have been prohibited had it been associated with an extension of credit. It should also prescribe the conditions for the preferential rate in such a way as to limit the discretion of the Loan Officer in determining whether the applicant has satisfied the conditions for the loan.
With respect to disclosures, we offer the following comments:
1. The preferential rate should be prescribed by the promissory note, with a description of when it is applicable, when it goes into effect, and when it is terminated.
2. For closed-end loans generally, such a feature will make them variable rate loans, as per section 1026.18(f) of Regulation Z, with disclosures of how the rate can change, under what circumstances, and with what effect.
3. Closed-end loans with such a feature which are secured by the borrower’s primary residence and have a term greater than one year will be considered adjustable rate mortgages or “ARMS” under section 1026.18(s)(7)(i) of Regulation Z. The Bank would, therefore, use model clause H-4(F), showing the preferential rate in the introductory rate column and the normal customer rate in the (maximum ever) column. The Bank would also have to determine how quickly the maximum rate would be reached after the underlying condition for the discount terminated.
4. The appropriate disclosure for an ARM with this discount feature, however, would be more limited than those for conventional ARMs. The Official Interpretations provide as follows:
Preferred-rate loans where the terms of the legal obligation provide that the initial underlying rate is fixed but will increase upon the occurrence of some event, such as an employee leaving the employ of the creditor, and the note reflects the preferred rate. The disclosures under sections 1026.19(b)(1) and 226.19(b)(2)(v), (viii), (ix), and (xii) are not applicable to such loans. Official Interpretations, ¶1026.19(b)-5(B).
This means that the ARMs brochure will not have to be given and that the disclosures will not include a statement that the interest rate will be discounted, payment disclosures based upon a $10,000 loan, or a statement that disclosure forms are available for the Bank’s other variable rate loans.
The Bank will have to state that the rate of interest, payment, or term of loan can change, the formula to be used in making adjustments, an explanation of how the interest rate and payment will be determined, and a statement that the consumer should ask about the margin and current interest rate.
5. Under RESPA rules, the date on which the “preferred” rate may expire (if expiration is due to such things as the consumer no longer having automatic loan payments or no longer being employed by the creditor) should be stated as “unknown” on the Good Faith Estimate of Settlement Costs and the HUD-1/1A Settlement Statement, as per the HUD RESPA FAQs:
If the first interest rate change date is not known due to a conditional rate feature, the first change date box should state unknown.
6. For open-end loans, the preferential rate will be disclosed as a variable rate, as per the requirements of sections 1026.6(b)(2) and 1026.40(b)(1) of Regulation Z.
7. For home equity lines of credit, a single disclosure form can be used for all plans, as long as the disclosure describes all aspects of the plans. Official Interpretations, ¶1026.40(a)(1)-4.