Some of our readers have asked for an explanation of the differences between the terms “direct lending” and “indirect lending,” and where does an “installment sale” fit in. Here is the answer in a nutshell:
In direct lending the finance company makes a loan to the consumer borrower. The transaction takes the form of a promissory note. The finance company is the creditor for Truth-in-Lending Act (TILA) disclosure purposes, and the Regulation Z Appendix H-2 Loan Model Form is the appropriate disclosure format.
Indirect lending actually does not involve a loan at all. Rather, a seller of goods or services sells to the consumer on a deferred payment basis. The transaction generally takes the form of an installment sales contract. For TILA and Regulation Z purposes, the installment seller is the creditor. The Regulation Z Appendix H-1 Credit Sale Model Form is the appropriate disclosure format.
In indirect lending, the bank or finance company takes assignment of the debt instrument—the installment sales contract—after the sales transaction is completed. As the assignee of the installment sales contract, the finance company then steps into the shoes of the seller to service the installment sale. As the “holder” of the installment sales contract, the finance company becomes subject to the claims and defenses that the consumer may assert against the seller under the Federal Trade Commission Holder-in-Due-Course Rule which we have written about previously. This blog is available by clicking here. So, while the finance company is not the initial creditor in the transaction, it becomes a creditor as the assignee of the installment sales transaction.
Interestingly, the TILA liability for a violation of the disclosure law differs based on the status of the finance company. As a direct lender, a finance company is liable for failing to comply with any and all requirements of TILA. As an indirect lender, a finance company is liable only for violations that are apparent on the face of the disclosure statement. This is a significant difference.
The distinction between indirect lending and direct lending plays out in many of the other consumer laws and regulations that we have written about. It also yields different results in various state laws—especially in licensing. But, the different liability treatment under TILA is of utmost significance to finance companies.
Please note: This is the fifty-first blog in a series of Back to Basics blogs, in which relevant and resourceful information can be easily accessed by clicking here.