Finance Charges Included or Not? The NCUA’s Interest Rate Ceiling

By Chris Price, CAMS, AMLP

Senior Consultant, Regulatory Advisory Services

In conventional Truth in Lending(TILA)/Regulation Z compliance, the interest is one of several finance charges making up the larger “Finance Charge.” These “smaller” finance charges are the various fees charged for borrowing money, and taken together, tally up to the Finance Charge, which is defined as the cost of credit expressed as a dollar amount. Thus, interest is a component of the Finance Charge.  The interest rate is interest expressed as a percentage.   The Annual Percentage Rate is the cost of credit expressed as an annualized percentage. So as interest is a component of the Finance Charge, the interest rate is part of the Annual Percentage Rate.  The question we tackle here, does the NCUA’s Interest Rate Ceiling include finance charges?  The answer is not so intuitive and getting it wrong can violate NCUA rules.

Found in 12 CFR 701.21(c)(7)(i) of the NCUA’s regulations, Federal Credit Unions are prohibited from extending credit to members in excess of 18% per annum. This is also a common usury rate prohibition set by state law for lending institutions. However, unlike our understanding of interest as we commonly know it in conventional TILA/Regulation Z compliance, the interest rate referenced in the NCUA’s regulation is not merely one component of the overall Finance Charge, but rather is inclusive of the various fees that are used to calculate both the overall Finance Charge and the Annual Percentage Rate. In fact, the NCUA regulation referenced herein states as follows: “federal credit unions may not extend credit to members at rates exceeding (18) percent per year on the unpaid balance inclusive of all finance charges.” (Note the e-CFR still reads “15 percent”). The “Finance Charge” for this usury provision is defined the same as that in Regulation Z, 12 CFR 1026.4(a), so that definition of finance charge is our starting point for calculating the NCUA’s Interest Rate Ceiling. Likewise, those fees excluded from the Finance Charge in 12 CFR 1026.4(c), are excluded from the NCUA’s Interest Rate Ceiling.

Now we have crossed the bridge of understanding the difference between the conventional definition of interest and that of the NCUA’s regulation, next is considering the calculation for any borrower. Closed-end credit is generally more straight forward than open-end credit. There are fees that may be included for open-end credit that may not be included in closed-end credit, such as transaction fees.  And if these fees that are usually only applicable to open-end credit are charged on any particular member, say one using their credit card, it must be part of the calculation to determine if the 18% ceiling will be breached. If so, then the fee must not be charged.

So the challenge here is multifaceted. First, compliance personnel must be trained to understand the intricacies of both the NCUA Interest Rate Ceiling and Regulation Z’s exclusions from the definition of Finance Charge. Second, Federal credit unions must have their software properly programmed to recognize which charges are finance charges and refrain from charging them to members when applying the charge will cause the interest rate to exceed 18% (or the ceiling rate in effect at any given time).  The first consideration can be readily addressed by use of Capco RAS’ Finance Charge Quick Reference Guide, which provides the definition as well as inclusions and exclusions. Look to Client Portal, on the Knowledge Base Tab, Quick Reference Guides, under Lending.  For programming software, make arrangements with your vendor to discuss the compliance requirement, and, when changes are made, ensure that rigorous testing is done under various circumstances before going live.