On October 1, 2015, the Department of Defense (“DOD”) final rule amending its implementing regulation under the Military Lending Act (“MLA”) goes into effect (the “MLA Rule”). Most creditors will have until October 3, 2016 to transition to the new method for conducting a covered-borrower check, while credit card accounts under an open-end consumer credit plan will have until October 3, 2017 to bring their practices into full compliance. With this MLA Rule, the DOD—the stealth bank regulator—has expanded the types of closed-end and open-end credit products that will be covered by the provisions of the MLA, including the 36% “military annual percentage rate” (“MAPR”), which includes all interest, fees, and charges associated with a loan, such as charges for ancillary or “add-on” products related to the credit.
The MLA Rule extends the MLA and the MAPR to all types of small dollar or payday loans, vehicle titles, refund anticipation loans, deposit advance and installment loans, unsecured open-end lines of credit, and even credit cards made to service members and their families. The MLA Rule also mandates additional compliance measures related to the offering of certain financial products and services, and streamlines information that a creditor must provide to covered borrowers when completing consumer credit transactions. The DOD, which appears to be taking a page from the Consumer Financial Protection Bureau (“CFPB”) playbook, has created a “safe harbor” for creditors that undertake certain safeguards for service members, including using the DOD-operated online MLA database to determine whether a consumer-applicant is indeed covered by the rule.
In sum, the MLA Rule’s regulatory changes will place a significant compliance burden on lenders who seek to offer certain consumer credit products to service members and their families. The substantial risks of noncompliance include potential civil and criminal liability, the voiding of contracts at inception, and other relief available under state law. This well-deserved protection for our nation’s service members comes with a hefty burden that will require a review of internal controls and risk management procedures on the part of lenders to ensure regulatory compliance and avoid the ire of the DOD, state attorneys general, and the CFPB.
II. The Military Lending Act and its Implementing Regulation
The DOD’s MLA Rule mirrors the consumer protection modus operandi of the CFPB, preferring regulatorily-imposed protection over consumer education. The genesis of the MLA regulation stems from the Talent-Nelson amendment to the John Warner National Defense Authorization Act of 2007, which required the DOD to write regulations to implement the Act. Thus, DOD implemented regulations that contained limitations and requirements for certain types of consumer credit extended to active duty service members and their spouses, children, and other dependents.
Initially, the DOD applied the MLA regulations only to three narrowly-defined consumer products: (1) payday loans; (2) vehicle title loans; and (3) tax refund anticipation loans, provided that these products meet the definition of a credit under the Regulation Z (the right to defer payment of debt or to incur debt and defer its payment). The initial MLA regulation mandated, among other things, the following:
- Specific criteria necessary for consumer products to be considered payday, vehicle title, and tax refund anticipation loans;
- A specific method for calculating the MAPR or military interest rate;
- An interest rate limit or cap;
- A process for verifying the identity of service members; and
- Certain consumer disclosures.
The original calculation for the MAPR was based on the costs associated with determining the typical Annual Percentage Rate (“APR”), as defined for closed-end credit transactions under Regulation Z, with the inclusion of certain additional costs listed in the regulation. These costs included interest, fees, credit service charges, credit renewal charges, credit insurance premiums including charges for single premium credit insurance, fees for debt cancellation or debt suspension agreements, and fees for credit-related ancillary products sold in connection with and either at or before consummation of the credit transaction. Certain other costs were not originally factored into the MAPR, such as unanticipated late payments, default, taxes, or fees prescribed by law or paid to public officials in relation to a security interest, or tax preparation fees. In addition, the initial regulation prohibited rollovers or renewals related to loans covered by the regulations at the time of loan origination. The DOD’s initial regulation also required service members to state affirmatively whether they or their dependents were covered by the regulation by indicating their military status at the time of application. Further, to verify the identity of service members, creditors had the option of obtaining proof of military service (via military identification or earnings and leave statements), obtaining a copy of active duty orders (for reservists), or checking the military database. Any violation of the regulation resulted in a federal criminal misdemeanor, voiding of the contract, and other relief available under state law.
III. The Final MLA Rule and Compliance Considerations
Considering the strict definition for each product covered by the initial regulation (payday, vehicle title, and tax refund anticipation), the DOD raised the specter that some creditors found ways to circumvent the regulation, which detrimentally affected our service members. For example, various payday lenders evaded the regulation by issuing loans above the regulation’s specified $2,000 ceiling or with a repayment term longer than 91 days. In response to this activity, in late 2014, the DOD consulted with the Board of Governors of the Federal Reserve System, the CFPB, the Department of the Treasury, the Federal Deposit Insurance Corporation, the Federal Trade Commission, and the National Credit Union Administration to draft amendments to the MLA’s implementing regulation.
The result of this multi-agency collaboration is the DOD’s MLA Rule, which brings a wider range of credit products under the purview of the law. Perhaps most notably, the MLA Rule expands the types of closed-end and open-end credit products covered by the provisions of the MLA. Payday loans, vehicle titles, refund anticipation loans, deposit advance and installment loans, unsecured open-end lines of credit, and credit cards must now comply with certain lending and disclosure terms, including the following:
- A 36% MAPR cap, which now includes all interest, fees, and charges associated with a loan, as well as most charges for ancillary “add-on” products. Under the MLA Rule, an application fee, participation fee, transaction-based fee, or similar fee (other than a periodic rate) for a charge may be excluded from the MAPR to the extent that the fee is a bona fide fee and reasonable for that type of fee.
- The satisfaction of other MLA terms and conditions, including the provision of certain information before or at the time the borrower becomes obligated on the transaction or establishes the account, refraining from requiring the borrower to submit to arbitration in the case of a dispute involving the consumer credit, and refraining from charging a penalty fee if the borrower prepays all or part of the consumer credit.
- For creditors seeking a safe harbor for compliance with the MLA Rule, the use of either the MLA database or information contained in a consumer report obtained from a nationwide consumer reporting agency in order to conclusively determine whether a consumer applicant is a covered-borrower.
While the DOD seeks to minimize the compliance burden on lenders by providing a safe harbor for those lenders who verify the status of a consumer using the MLA database, the MLA Rule does not address creditors’ concerns about the effectiveness of relying on this database for compliance. For example, multiple creditors submitted comments on the proposed rule indicating concerns about the impact of technological glitches and inaccurate information within the MLA database on the applicability of the safe harbor. The MLA Rule does not address or resolve these questions.
IV. Action Plan
To avoid potential regulatory inquiries that may result in civil liability and criminal prosecution, any provider of consumer financial products and services must ensure that its products and services are in full compliance with the requirements of the MLA Rule and that their compliance processes address these requirements to avoid illegal lending to military families.
Based on the new rule, there are a number of action items that creditors should consider when reviewing their lending practices for MLA compliance. Affected creditors should, at a minimum, consider the following action items:
- Evaluate whether their products and services are being offered to service members and their families;
- Review whether existing or contemplated credit products fall within the broad scope of the MLA Rule;
- Analyze fee structures applicable to credit products available to service members, including add-on products, to determine compliance with the 36% MAPR limit;
- Determine whether modifications to internal compliance policies and procedures are necessary to ensure compliance with the MLA Rule;
- Review loan documents for mandatory arbitration clauses and other language that may violate the MLA Rule and make revisions as necessary;
- Implement internal policies and procedures that require querying each consumer-applicant’s name in the DOD’s MLA database if seeking to rely on the safe harbor; and
- For credit card lenders, consider the regulatory burden of compliance and, if necessary, prepare correspondence to the Secretary of Defense requesting an additional year’s grace period for compliance, as provided for in the MLA Rule.