Since the market crash of 2008, a number of private education lenders have left the marketplace. Those who have remained have not increased their lending to fill this gap and anecdotal evidence suggests that the remaining lenders have further reduced access to private education loans by tightening their credit criteria. Higher-education institutions have responded to the credit needs left unmet in the current marketplace by creating or revising their own institutional credit and payment arrangements. While there is certainly a place for institutional credit and payment arrangements, institutions should be aware of the issues that such arrangements may pose under state and federal law.
1. Is it credit?
Most institutions require students to pay tuition in full by a specific date. Some institutions have a policy where a student who does not pay in full by that date is charged a "late fee" expressed as a percentage of the amount due or as a flat dollar amount. If the student doesn't pay on time and the institution allows the student to carry the balance subject to the "late fee," has the school extended credit to the student?
Under the federal Truth in Lending Act (TILA), there would be an extension of credit if the student has incurred the obligation to pay the entire amount of tuition and had the right to defer payment of all or part of the tuition. Because the credit is for the purpose of financing postsecondary educational expenses, the extension of credit would be a private education loan subject to additional disclosure requirements, unless the extension of credit met one of the exceptions set forth in Regulation Z, TILA's implementing regulation. Those exceptions are either the emergency loan exception or the tuition payment plan exception. If the arrangement didn't meet either exception, then the arrangement would be a private education loan subject to additional disclosure requirements. If the arrangement did meet an exception, then it would not be exempt from Regulation Z, but subject to the general credit regulations that govern all other types of closed-end credit.
2. If so, is the extension of credit subject to Regulation Z?
Possibly, but we may be getting ahead of ourselves. Although a school's plan to accommodate a student's unmet credit needs may be consumer credit, an extension of credit should not be confused with arrangements to collect past due balances. If a student hasn't paid by the payment due date, the student has definitely incurred an obligation, so the key issue is whether the student had the right to defer payment of the obligation. If tuition is simply due on a particular day, the failure of the student to pay on that day is not an extension of credit because the school did not give the student a right to defer the payment of the outstanding tuition beyond that day. Does the answer change if the school assesses a "late fee" or a "service charge" when the student fails to pay the balance when due? The answer should be no because the student is actually in default of his obligation to pay tuition by a stated due date. The assessment of a penalty on the student for a failure to pay on time does not turn his default into an extension of credit.
If the student does have the right to defer payment of his obligation, the school has extended the student credit, but the credit either has to be subject to a finance charge or payable in more than four installments to be subject to Regulation Z. Counting the number of installments is easy, but the concept of a "finance charge" is more complicated. A "finance charge" is any cost of credit and includes both interest as well as one-time fees paid by the consumer when the credit is extended. The key factor in determining whether a fee is a finance charge is whether the fee is payable by all consumers in both cash and credit transactions or if it is payable only by consumers who do not pay in cash. If the fee is paid only by non-cash consumers, the fee is probably a finance charge.
Let's consider the following example to illustrate this point. Assume that a student, after applying all of his aid toward his cost of attendance, still owes the school $1,000. The school offers the student several options for paying this amount. One option requires the student to pay the $1,000 before enrolling for his or her second year. If no interest or finance charges accrues on the $1,000 of outstanding tuition and the $1,000 balance is payable in one lump sum before the second year, then the school has extended credit that is not subject to Regulation Z. If the school either requires the student to pay the $1,000 in five installments or if it assesses a finance charge (or "service charge," "carrying charge," "administrative fee," "deferred payment fee," etc.) for the privilege of having a deferred payment due date, then the school has extended credit subject to Regulation Z. If the term of the credit exceeded 12 months, then this extension of credit is also subject to additional requirements specific to private education loans.
3. If there is an extension of credit, is the extension of credit a private education loan subject to Subpart F?
If the payment arrangement between the school and the student is an extension of credit subject to Regulation Z, the next issue to consider is whether the credit is a private education loan. A private education loan is subject to special requirements set forth in Subpart F of Regulation Z, rather than the requirements that regulate open-end credit or closed-end credit. Subpart F defines a private education loan as a loan that is extended to a consumer expressly, in whole or in part, for postsecondary educational expenses, regardless of whether the loan is provided by the educational institution that the student attends. A private education loan does not include a Title IV loan, an open-end loan, or a loan secured by a dwelling. Regulation Z also provides two exceptions to the definition of a private education loan that may apply to institutions that extend credit to help meet a student's unmet credit needs and are discussed below.
There are several things to note about this definition. First, the purpose of the loan is significant. The loan has to be for the purpose of financing postsecondary educational expenses. Second, the identity of the creditor is not significant. Whether the school, a bank, or someone else extends the credit does not matter; only the purpose of the loan matters. Next, the structure of the loan is significant. If the loan is set up as a line of credit, or if the loan is secured by home equity, the loan is not a private education loan even if it otherwise meets the definition of a private education loan.
If a loan is a private education loan, then the school must comply with the requirements of Subpart F. Other than a few substantive requirements, such as a prohibition on prepayment penalties, the creation of a loan term lock-in period and the creation of a right to cancel, loan terms are not regulated by Subpart F, but by state law. The main requirements of Subpart F are disclosure requirements.
Subpart F requires a private education loan creditor to provide disclosures to the consumer with an application or solicitation for the loan, when the loan application is approved, and at consummation of the loan. In creating these disclosure requirements, Subpart F assumes the process begins with either an application, meaning a request for the loan by the borrower, or with a solicitation, meaning a grant of the loan by the creditor without the borrower having made an application. In either case, the creditor must provide the consumer with a disclosure that describes the creditor's loan program rather than a particular loan. If the consumer submits an application (or accepts a loan solicitation) and is approved, the creditor then must provide the consumer with an approval disclosure. This disclosure contains the terms of the specific loan being offered and must be provided to the consumer when the creditor informs the consumer that the loan application has been approved.
The approval disclosure also implements the loan term lock-in mentioned above. Once the loan approval disclosure has been provided, the consumer has 30 days to accept the terms of the loan offer. During that time, except for very limited reasons, the creditor can not change the terms of the loan offer. The creditor can specify the manner by which the consumer can accept the offer, as long as the consumer actively accepts the offer, that is, the offer cannot be deemed accepted unless rejected.
After the consumer has accepted the offer, the creditor must send the consumer a final disclosure. The final disclosure is very similar to the approval disclosure but adds an additional disclosure regarding the consumer's right to cancel. Subpart F gives the consumer three days from receiving the final disclosures to cancel the loan and, during the cancellation period, the creditor can not disburse the loan.
Federal regulations provide models for all three disclosure forms. Use of the model forms provides a safe harbor for compliance with Subpart F, but some changes are allowed, if not required, depending on the terms of an institution's loan program. The disclosures include both narrative and numerical elements. Completing the disclosures accurately and in a way that complies with Subpart F is technically challenging, particularly with respect to the numerical disclosures, so schools that are subject to Subpart F should seek qualified legal assistance. In any event, the disclosures must reflect the terms of the obligation between the parties. The disclosures merely disclose the terms of the obligation in a uniform manner. The disclosures, by themselves, will not create an obligation. The obligation has to be documented in a contract or promissory note.
4. If there is an extension of credit for postsecondary educational expenses, does the extension of credit meet one of the exceptions to the coverage of Subpart F?
There are two exceptions to the definition of a private education loan that apply only when a school is the creditor. A loan that otherwise meets the definition of a private education loan is not covered by Subpart F if the school is the creditor and either: 1) the extension of credit is for 90 days or less; or 2) an interest rate will not be applied to the outstanding balance and the credit term is one year or less.
The first exception is known as the emergency loan exception. A school can make a loan to a borrower for up to 90 days, charge interest on the loan if it wishes and avoid Subpart F. The second exception is known as the tuition payment plan exception. A tuition payment plan can have a term of up to one year and not be considered a private education loan as long as the school does not charge any interest. Note that this exception refers only to "interest." As discussed above, interest is only one type of finance charge under Regulation Z. Because the tuition payment plan exception refers only to interest, a school can charge a finance charge (such as an enrollment fee, a set-up fee, etc.) and still qualify for the exception. In either the case of an emergency loan or a tuition payment plan, an extension of credit that meets the applicable definition is outside the coverage of Subpart F. That means, in turn, that the school will not have to give borrowers the three private education loan disclosures.
Although the two exceptions eliminate a school's need to use the three private education loan disclosures, emergency loans and tuition payment plans pose some technical compliance issues of their own. A common source of confusion is the fact that some parts of Regulation Z continue to apply even if the plan is not a private education loan. Payment arrangements, such as a tuition payment plan, are still subject to the general closed-end credit requirements of Regulation Z even though they are exempt from the private education loan provisions of Regulation Z. Schools will need to use the traditional single disclosure statement required by Regulation Z even if the plan qualifies for an exception from the definition of a private education loan discussed above. The general closed-end credit disclosures require calculations that may be challenging and schools should seek qualified assistance in preparing such disclosures.
Arthur Rotatori is a consumer finance attorney at McGlinchey Stafford PLLC.
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