When Finance Products Become Finance Charges

April 30th, 2015

by Leonard A. Bellavia, Esq. Senior Partner, Bellavia Blatt & Crossett, PC

Suppose your sales manager and credit manager have discussed at length how to increase the company’s extended service contract penetration and gross profit.  One day, the credit manager runs up to the sales manager and shouts “Eureka!”  The credit manager explains that she will tell consumers that they can get lower interest rates on their loans if they agree to purchase extended service contracts.  The credit manager’s idea seems like a win-win.  The consumer pays less in interest charges and gets coverage that mitigates the cost of repairs while the company profits.  What could go wrong?

Unfortunately many businesses, when faced with this same opportunity, would think that this proposal was a great way to increase back end profits.  While doing so may lead to profits today, the business is now at risk of penalties for breaking numerous state and federal laws.  One such law addresses how businesses must disclose finance charges to consumers.  Regulation “Z” defines a finance charge as “the cost of consumer credit as a dollar amount.  It includes any charge payable directly or indirectly by the consumer and imposed directly or indirectly by the creditor as an incident to or a condition of the extension of credit.”  A business must properly disclose any and all finance charges on the retail installment sales contract.  Offering to reduce the interest rate on the consumer’s loan in exchange for the consumer purchasing an extended service contract turns the sale of the service contract into a finance charge.  The cost of the extended service contract is now a “cost of consumer credit as a dollar amount” levied because the consumer’s choice to purchase the extended service contract is “an incident to or a condition of the extension of credit.”

Instead of offering a rate discount in exchange for the purchase of an extended service contract, some businesses may tell the consumer that the bank requires the buyer to purchase a service contract as a condition of the loan when in fact the bank does not.  This approach may even be more egregious because there is now an added component of fraud that the consumer may claim.  All finance charges must be appropriately disclosed on the retail installment sales contract.  Tying a loan approval or rate concessions to the purchase of finance products or accessories creates finance charges that must be properly disclosed on the contract.  If the finance charge is not properly disclosed, your business can face investigation and penalties.

Many people saw their financial security shaken during the recession of 2008 and the sluggish recovery since.  Consumers’ credit scores declined as they struggled to pay mortgages and find employment.  The regulatory environment is sympathetic to consumers, as evidenced by the increased attention lawmakers have placed on banking and lending practices.  The reduced buying power of the public and other factors have compressed margins and slowed sales.  Your people may have developed “creative” ways to maximize sales and gross profits.  Do not wait for a lawsuit or action by a state or federal regulatory agency to compel you to ask how your staff presents finance products to consumers.  With proper training and solid processes, your staff can maximize profits while maintaining compliance with laws like Regulation “Z.”

As always, our firm is here to help answer any questions you may have about Regulation “Z” and any other laws that may impact the practices at your business.  Please call us at 631-234-7000.

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