BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM
Introduction
The Consumer Credit Protection Act of 1968--which launched Truth in Lending--was a landmark piece of legislation. For the first time, creditors had to state the cost of borrowing in a common language so that you--the customer--could figure out exactly what the charges would be, compare costs, and shop around for the credit deal best for you.
Since 1968, credit protections have multiplied rapidly. The concepts of "fair" and "equal" credit have been written into laws that outlaw unfair discrimination in credit transactions; require that consumers be told the reason when credit is denied; let borrowers find out about their credit records; and set up a way to settle billing disputes.
Each law was meant to reduce the problems and confusion surrounding consumer credit which, as it became more widely used in our economy, also grew more complex. Together, these laws set a standard for how individuals are to be treated in their financial dealings.
The laws say, for instance:
-- that you cannot be turned down for a credit card just because you're a single woman;
-- that you can limit your risk if a credit card is lost or stolen;
-- that you can straighten out errors in your monthly bill without damage to your credit rating; and
-- that you won't find credit shut off just because you've reached the age of 65.
But, let the buyer be aware! It is important to know your fights and how to use them. This handbook explains how the consumer credit laws can help you shop for credit, apply for it, keep up your credit standing, and--if need be--complain about an unfair deal. It explains what you should look for when using credit and what creditors look for before extending it. It also points out the laws' solutions to discriminatory practices that have made it difficult for women and minorities to get credit in the past.
The Cost Of Credit
Shopping is the First Step
You get credit by promising to pay in the future for something you receive in the present.
Credit is a convenience. It lets you charge a meal on your credit card, pay for an appliance on the installment plan, take out a loan to buy a house, or pay for schooling or vacations. With credit, you can enjoy your purchase while you're paying for it--or you can make a purchase when you're lacking ready cash.
But there are strings attached to credit too. It usually costs something. And of course what is borrowed must be paid back.
If you are thinking of borrowing or opening a credit account, your first step should be to figure out how much it will cost you and whether you can afford it. Then you should shop around for the best terms.
What Laws Apply?
Two laws help you compare costs:
TRUTH IN LENDING requires creditors to give you certain basic information about the cost of buying on credit or taking out a loan. These "disclosures" can help you shop around for the best deal.
CONSUMER LEASING disclosures can help you compare the cost and terms of one lease with another and with the cost and terms of buying for cash or on credit.
The Finance Charge and Annual Percentage Rate (APR)
Credit costs vary. By remembering two terms, you can compare credit prices from different sources. Under Truth in Lending, the creditor must tell you--in writing and before you sign any agreement--the finance charge and the annual percentage rate.
The finance charge is the total dollar amount you pay to use credit. It includes interest costs, and other costs, such as service charges and some credit--related insurance premiums.
For example, borrowing $100 for a year might cost you $10 in interest. If there were also a service charge of $1, the finance charge would be $11.
The annual percentage rate (APR)is the percentage cost (or relative cost) of credit on a yearly basis. This is your key to comparing costs, regardless of the amount of credit or how long you have to repay it:
Again, suppose you borrow $100 for one year and pay a finance charge of $10. If you can keep the entire $100 for the whole year and then pay back $110 at the end of the year, you are paying an APR of 10 percent.
But, if you repay the $100 and finance charge (a total of $110) in twelve equal monthly installments, you don't really get to use $100 for the whole year. In fact, you get to use less and less of that $100 each month. In this case, the $10 charge for credit amounts to an APR of 18 percent.
All creditors--banks, stores, car dealers, credit card companies, finance companies-must state the cost of their credit in terms of the finance charge and the APR. Federal law does not set interest rates or other credit charges. But it does require their disclosure so that you can compare credit costs. The law says these two pieces of information must be shown to you before you sign a credit contract or before you use a credit card.
A Comparison
Even when you understand the terms a creditor is offering, it's easy to underestimate the difference in dollars that different terms can make. Suppose you're buying a $7,500 car. You put $1,500 down, and need to borrow $6,000. Compare the three credit arrangements on the next page.
How do these choices stack up? The answer depends partly on what you need.
The lowest cost loan is available from Creditor A.
If you were looking for lower monthly payments, you could get then by paying the loan off over a longer period of time. However, you would have to pay more in total costs. A loan from Creditor B--also at a 14 percent APR, but for four years--will add about $488 to your finance charge.
If that four-year loan were available only from Creditor C, the APR of 15 percent would add another $145 or so to your finance charges as compared with Creditor B.
Other terms--such as the size of the down payment--will also make a difference. Be sure to look at all the terms before you make your choice.
Cost of Open-end Credit
Open-end credit includes bank and department store credit cards, gasoline company cards, home equity lines, and check overdraft accounts that let you write checks for more than your actual balance with the bank. Open-end credit can be used again and again, generally until you reach a certain prearranged borrowing limit. Truth in Lending requires that open-end creditors tell you the terms of the credit plan so that you can shop and compare the costs involved.
When you're shopping for an open-end plan, the APR you're told represents only the periodic rate that you will be charged--figured on a yearly basis. (For instance, a creditor that charges 1% percent interest each month would quote you an APR of 18 percent.) Annual membership fees, transaction charges, and points, for example, are listed separately; they are not included in the APR. Keep this in mind and compare all the costs involved in the plans, not just the APR.
Creditors must tell you when finance charges begin on your account, so you know how much time you have to pay your bill before a finance charge is added. Creditors may give you a 25-day grace period, for example, to pay your balance in full before making you pay a finance charge.
Creditors also must tell you the method they use to figure the balance on which you pay a finance charge; the interest rate they charge is applied to this balance to come up with the finance charge. Creditors use a number of different methods to arrive at the balance. Study them carefully; they can significantly affect your finance charge.
Some creditors, for instance, take the amount you owed at the beginning of the billing cycle, and subtract any payments you made during that cycle. Purchases are not counted. This is called the adjusted balance method.
Another is the previous balance method. Creditors simply use the amount owed at the beginning of the billing cycle to come up with the finance charge.
Under one of the most common methods-the average daily balance method--creditors add your balances for each day in the billing cycle and then divide that total by the number of days in the cycle. Payments made during the cycle are subtracted in arriving at the daily amounts, and, depending on the plan, new purchases may or may not be included. Under another method--the two-cycle average daily balance method--creditors use the average daily balances for two billing cycles to compute your finance charge. Again, payments will be taken into account in figuring the balances, but new purchases may or may not be included.
Be aware that the amount of the finance charge may vary considerably depending on the method used, even for the same pattern of purchases and payments.
If you receive a credit card offer or an application, the creditor must give you information about the APR and other important terms of the plan at that time. Likewise, with a home equity plan, information must be given to you with an application.
Truth in Lending does not set the rates or tell the creditor how to calculate finance charges--it only requires that the creditor tell you the method that it uses. You should ask for an explanation of any terms you don't understand.
Leasing Costs and Terms
Leasing gives you temporary use of property in return for periodic payments. It has become a popular alternative to buying--under certain circumstances. For instance, you might consider leasing furniture for an apartment you'll use only for a year. The Consumer Leasing law requires leasing companies to give you the facts about the costs and terms of their contracts, to help you decide whether leasing is a good idea.
The law applies to personal property leased to you for more than four months for personal, family, or household use. It covers, for example, long-term rentals of cars, furniture, and appliances, but not daily car rentals or leases for apartments.
Before you agree to a lease, the leasing company must give you a written statement of costs, including the amount of any security deposit, the amount of your monthly payments, and the amount you must pay for licensing, registration, taxes, and maintenance.
The company must also give you a written statement about terms, including any insurance you need, any guarantees, information about who is responsible for servicing the property, any standards for its wear and tear, and whether or not you have an option to buy the property.
Open-end Leases and Balloon Payments
Your costs will depend on whether you choose an open-end lease or a closed-end lease. Open-end leases usually mean lower monthly payments than closed-end leases, but you may owe a large extra payment--often called a balloon payment--based on the value of the property when you return it.
Suppose you lease a car under a three-year open-end lease. The leasing company estimates the car will be worth $4,000 after three years of normal use. If you bring back the car in a condition that makes it worth only $3,500, you may owe a balloon payment of $500.
The leasing company must tell you whether you may owe a balloon payment and how it will be calculated. You should also know that:
-- you have the right to an independent appraisal of the property's worth at the end of the lease. You must pay the appraiser's fee, however.
-- a balloon payment is usually limited to no more than three times the average monthly payment. If your monthly payment is $ 200, your balloon payment wouldn't be more than $600--unless, for example, the property has received more than average wear and tear (for instance, if you drove a car more than average mileage).
Closed-end leases usually have higher monthly payment than open-end leases, but there is no balloon payment at the end of the lease.
Costs of Settlement on a House
A house is probably the single largest credit purchase for most consumers--and one of the most complicated. The Real Estate Settlement Procedures Act, like Truth in Lending, is a disclosure law. The Act, administered by the Department of Housing and Urban Development, requires the lender to give you, in advance, certain information about the costs you will pay when you close the loan.
This event is called settlement or closing, and the law helps you shop for lower settlement costs. To find out more about it, write to:
Deputy Assistant Secretary for Housing Attention:
RESPA Enforcement U.S. Department of Housing and Urban Development
451 Seventh Street, S.W. Room 5241
Washington, D.C. 20410
Should you need to phone:
(202) 708-4560
A Federal Reserve pamphlet, entitled "A Consumer's Guide to Mortgage
Closing Costs," also contains useful information for consumers.
Applying For Credit
Discrimination
When you're ready to apply for credit, you should know what creditors think is important in deciding whether you're creditworthy. You should also know what they cannot legally consider in their decisions.
What Law Applies?
EQUAL CREDIT OPPORTUNITY ACT requires that all credit applicants be considered on the basis of their actual qualifications for credit and not be turned away because of certain personal characteristics.
What Creditors Look For
The Three C's. Creditors look for an ability to repay debt and a willingness to do so--and sometimes for a little extra security to protect their loans. They speak of the three C's of credit-capacity, character, and collateral.
Capacity. Can you repay the debt? Creditors ask for employment information: your occupation, how long you've worked, and how much you earn. They also want to know your expenses: how many dependents you have, whether you pay alimony or child support, and the amount of your other obligations.
Character. Will you repay the debt? Creditors will look at your credit history (see chapter on Credit Histories and Records): how much you owe, how often you borrow, whether you pay bills on time, and whether you live within your means. They also look for signs of stability: how long you've lived at your present address, whether you own or rent, and length of your present employment.
Collateral. Is the creditor fully protected if you fail to repay? Creditors want to know what you may have that could be used to back up or secure your loan, and what sources you have for repaying debt other than income, such as savings, investments, or property.
Creditors use different combinations of these facts in reaching their decisions. Some set unusually high standards and other simply do not make certain kinds of loans. Creditors also use different kinds of rating systems. Some rely strictly on their own instinct and experience.
Others use a "credit-scoring" or statistical system to predict whether you're a good credit risk. They assign a certain number of points to each of the various characteristics that have proved to be reliable signs that a borrower will repay. Then, they rate you on this scale.
And so, different creditors may reach different conclusions based on the same set of facts. One may find you an acceptable risk, while another may deny you a loan.
Information the Creditor Can't Use
The Equal Credit Opportunity Act does not guarantee that you will get credit. You must still pass the creditor's tests of creditworthiness. But the creditor must apply these tests fairly, impartially, and without discriminating against you on any of the following grounds: age, gender, marital status, race, color, religion, national origin, because you receive public income such as veterans benefits, welfare or Social Security, or because you exercise your rights under Federal credit laws such as filing a billing error notice with a creditor. This means that a creditor may not use any of those grounds as a reason to:
-- discourage you from applying for a loan;
-- refuse you a loan if you quality; or
-- lend you money on terms different from those granted another person with similar income, expenses, credit history, and collateral.
Special Rules
Age. In the past, many older persons have complained about being denied credit just because they were over a certain age. Or when they retired, they often found their credit suddenly cut off or reduced. So the law is very specific about how a person's age may be used in credit decisions.
A creditor may ask your age, but if you're old enough to sign a binding contract (usually 18 or 21 years old depending on state law), a creditor may not:
-- turn you down or offer you less credit just because of your age;
-- ignore your retirement income in rating your application;
-- close your credit account or require you to reapply for it just because you reach a certain age or retire; or
-- deny you credit or close your account because credit life insurance or other credit-related insurance is not available to persons your age.
Creditors may "score" your age in a creditscoring system, but:
-- if you are 62 or older you must be given at least as many points for age as any person under 62.
Because individuals' financial situations can change at different ages, the law lets creditors consider certain information related to age--such as how long until you retire or how long your income will continue. An older applicant might not qualify for a large loan with a 5 percent down payment on a risky venture, but might qualify for a smaller loan--with a bigger down payment--secured by good collateral. Remember that while declining income may be a handicap if you are older, you can usually offer a solid credit history to your advantage. The creditor has to look at all the facts and apply the usual standards of creditworthiness to your particular situation.
Public Assistance. You may not be denied credit just because you receive Social Security or public assistance (such as Aid to Families with Dependent Children). But--as is the case with age--certain information related to this source of income could clearly affect creditworthiness.
So, a creditor may consider such things as:
-- how old your dependents are (because you may lose benefits when they reach a certain age); or
-- whether you will continue to meet the residency requirements for receiving benefits.
This information helps the creditor determine the likelihood that your public assistance income will continue.
Housing Loans. The Equal Credit Opportunity Act covers your application for a mortgage or home improvement loan. It bans discrimination because of such characteristics as your race, color, gender, or because of the race or national origin of the people in the neighborhood where you live or want to buy your home. Nor may creditors use any appraisal of the value of the property that considers the race of the people in the neighborhood.
In addition, you are entitled to receive a copy of an appraisal report that you paid for in connection with an application for credit, if a you make a written request for the report.
Discrimination Against Women
Both men and women are protected from discrimination based on gender or marital status. But many of the law's provisions were designed to stop particular abuses that generally made if difficult for women to get credit. For example, the idea that single women ignore their debts when they marry, or that a woman's income "doesn't count" because she'll leave work to have children, now is unlawful in credit transactions.
The general rule is that you may not be denied credit just because you are a woman, or just because you are married, single, widowed, divorced, or separated. Here are some important protections:
Gender and Marital Status. Usually, creditors may not ask your gender on an application form (one exception is on a loan to buy or build a home).
You do not have to use Miss, Mrs., or Ms. with your name on a credit application. But, in some cases, a creditor may ask whether you are married, unmarried, or separated (unmarried includes single, divorced, and widowed).
Child-bearing Plans. Creditors may not ask about your birth control practices or whether you plan to have children, and they may not assume anything about those plans.
Income and Alimony. The creditor must count all of your income, even income from part-time employment.
Child support and alimony payments are a primary source of income for many women. You don't have to disclose these kinds of income, but if you do creditors must count them.
Telephones. Creditors may not consider whether you have a telephone listing in your name because this would discriminate against many married women. (You may be asked if there's a telephone in your home.)
A creditor may consider whether income is steady and reliable, so be prepared to show that you can count on uninterrupted income--particularly if the source is alimony payments or part-time wages.
Your Own Accounts. Many married women used to be turned down when they asked for credit in their own name. Or, a husband had to cosign an account--agree to pay if the wife didn't--even when a woman's own income could easily repay the loan. Single women couldn't get loans because they were thought to be somehow less reliable than other applicants. You now have a fight to your own credit, based on your own credit records and earnings. Your own credit means a separate account or loan in your own name--not a joint account with your husband or a duplicate card on his account. Here are the rules:
-- Creditors may not refuse to open an account just because of your gender or marital status.
-- You can choose to use your first name and maiden name (Mary Smith); your first name and husband's last name (Mary Jones); or a combined last name (Mary Smith-Jones).
-- If you're creditworthy, a creditor may not ask your husband to cosign your account, with certain exceptions when property rights are involved.
-- Creditors may not ask for information about your husband or ex-husband when you apply for your own credit based on your own income--unless that income is alimony, child support, or separate maintenance payments from your spouse or former spouse.
This last rule, of course, does not apply if your husband is going to use your account or be responsible for paying your debts on the account, or if you live in a community property state. (Community property states are: Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington and Wisconsin.)
Change in Marital Status. Married women have sometimes faced severe hardships when cut off from credit after their husbands died. Single women have had accounts closed when they married, and married women have had accounts closed after a divorce. The law says that creditors may not make you reapply for credit just because you marry or become widowed or divorced. Nor may they close your account or change the terms of your account on these grounds. There must be some sign that your creditworthiness has changed. For example, creditors may ask you to reapply if you relied on your ex-husband's income to get credit in the first place.
Setting up your own account protects you by giving you your own history of how you handle debt, to rely on if your financial situation changes because you are widowed or divorced. If you're getting married and plan to take your husband's surname, write to your creditors and tell them if you want to keep a separate account.
If You're Turned Down
Remember, your gender or race may not be used to discourage you from applying for a loan. And creditors may not hold up or otherwise delay your application on those grounds. Under the Equal Credit Opportunity Act, you must be notified within 30 days after your application has been completed whether your loan has been approved or not. If credit is denied, this notice must be in writing and it must explain the specific reasons why you were denied credit or tell you of your right to ask for an explanation. You have the same rights if an account you have had is closed.
If you are denied credit, be sure to find out why. Remember, you may have to ask the creditors for this explanation. It may be that the creditor thinks you have requested more money than you can repay on your income. It may be that you have not been employed or lived long enough in the community. You can discuss terms with the creditor and ways to improve your creditworthiness. The next chapter explains how to improve your ability to get credit.
If you think you have been discriminated against, cite the law to the lender. If the lender still says no without a satisfactory explanation, you may contact a Federal enforcement agency for assistance or bring legal action as described in the last chapter of this handbook.
