Limitations on Terms of Consumer Credit Extended to Service Members and Dependents, 50580-50594 [07-4264]

Agencies

• Office of the Secretary
• DEPARTMENT OF DEFENSE

[Federal Register Volume 72, Number 169 (Friday, August 31, 2007)]
[Rules and Regulations]
[Pages 50580-50594]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 07-4264]



[[Page 50579]]

-----------------------------------------------------------------------

Part VI





Department of Defense





-----------------------------------------------------------------------



32 CFR Part 232



 Limitations on Terms of Consumer Credit Extended to Service Members 
and Dependents; Final Rule

Federal Register / Vol. 72, No. 169 / Friday, August 31, 2007 / Rules 
and Regulations

[[Page 50580]]


-----------------------------------------------------------------------

DEPARTMENT OF DEFENSE

Office of the Secretary

32 CFR Part 232

[DOD-2006-OS-0216]
RIN 0790-AI20


Limitations on Terms of Consumer Credit Extended to Service 
Members and Dependents

AGENCY: Department of Defense (DoD).

ACTION: Final rule.

-----------------------------------------------------------------------

SUMMARY: The Department of Defense (the Department or DoD) is amending 
32 CFR by adding new regulations to implement the consumer protections 
provisions of Public Law 109-364, the John Warner National Defense 
Authorization Act for Fiscal Year 2007, section 670, ``Limitations on 
Terms of Consumer Credit Extended to Service Members and Dependents'' 
(October 17, 2006). Section 670 requires the Secretary of Defense to 
prescribe regulations to carry out the new section. The final rule 
regulates the terms of certain credit extensions to active duty service 
members and their dependents.

EFFECTIVE DATE: October 1, 2007.

FOR FURTHER INFORMATION CONTACT: Mr. George Schaefer, (703) 588-0876.

SUPPLEMENTARY INFORMATION:

I. Background

    Today's joint force combat operations require highly trained, 
experienced and motivated troops. We are fortunate that today's All 
Volunteer Force is comprised of individuals who fit the stringent 
requirements needed for success on the battlefield. The military has 
seen many changes since it became an All Volunteer Force in 1973. The 
technological advances over the ensuing 34 years have made remarkable 
transformations to the capabilities of the Armed Forces.
    These advances would not have been as easily attained if it were 
not for the All Volunteer Force. The members of this force have higher 
levels of aptitude, stay in the military longer, and as a consequence, 
perform better than their conscript predecessors. During the Vietnam 
era draft, 90 percent of conscripts quit after their initial two-year 
hitch, whereas retention of volunteers is five-times better today--
about half remain after their initial (four-year) military service 
obligation. Said another way, two thirds of the military was serving in 
its first two years of service prior to 1973, where as today, the 
number is about one-fourth.
    Today's Service members are still younger than the population as a 
whole, with 46 percent 25 years old or less. Thirty-eight percent of 
Service members 25 years old or less are married and 21 percent of them 
have children. This is compared with approximately 13 percent of their 
contemporaries in the U.S. population 18 through 24 who are married 
(2000 Census). The majority of recruits come to the military from high 
school, with little financial literacy education.
    The initial indoctrination provided to Service members is critical, 
providing basic requirements for their professional and personal 
responsibilities and their successful adjustment to military life. Part 
of this training is in personal finance, which is an integral part of 
their personal, and often, professional success. The Department of 
Defense (the Department) continues to provide them messages to save, 
invest, and manage their money wisely throughout their career.
    Service members and their families are experiencing the sixth year 
of the Global War on Terror. The Department views the support provided 
to military families as essential to sustaining force readiness and 
military capability. From this perspective, it is not sufficient for 
the Department to train Service members on how best to use their 
financial resources. Financial protections are an important part of 
fulfilling the Department's compact with Service members and their 
families.

Social Compact

    The Department believes that assisting Service members with their 
family needs is essential to maintaining a stable, motivated All 
Volunteer Force. As part of the President's February 2001 call to 
improve the quality of life for Service members and their families, the 
Department developed a social compact reflecting the Department's 
commitment to caring for their needs as a result of their commitment to 
serving the Nation. The social compact involved a bottom-up review of 
the quality-of-life support provided by the Department, which 
articulated the linkage between quality-of-life programs as a human 
capital management tool and the strategic goal of the Department--
military readiness.
    The social compact is manifested in the programs the Department 
provides to support the quality of life of Service members and their 
families. This social compact includes personal finances as an integral 
part of their quality of life. The Department equates financial 
readiness with mission readiness. When asked in 2005 on a blind survey 
to rate the stressors in their lives, Service members (as a group) 
rated finances as a more significant stressor than deployments, health 
concerns, life events, and personal relationships. They only rated work 
and career concerns as a higher stressor in their lives. As part of the 
social compact for financial readiness, the Department established a 
strategic plan to:
     Reduce the stressors related to financial problems. The 
stress associated with out-of-control debt impacts the performance of 
Service members and has a major negative impact on family quality of 
life.
     Increase savings. Establishing personal and family goals, 
helps motivate Service members to control their finances and live 
within their means.
     Decrease dependence on unsecured debt. This reduces the 
stressors and vulnerabilities associated with living from paycheck to 
paycheck.
     Decrease the prevalence of predatory practices. This 
provides protection from financial practices that seek to deceive 
Service members or take advantage of them at a time of vulnerability.
    The Department has taken action to obtain these outcomes by 
providing financial awareness, education, and counseling programs; by 
advocating the marketplace deliver beneficial products and services; 
and by advocating for the protection for Service members and their 
families from harmful products and practices.

Financial Education

    The Military Services are expected to provide instruction and 
information to fulfill the needs of Service members and their families. 
To this end, the Department established a policy in November 2004: DoD 
Instruction 1342.27, Personal Financial Management Programs for Service 
Members.
    As outlined in the Government Accountability Office (GAO) Report 
05-348, the Military Services have their own programs for training 
first-term Service members on the basics of personal finance. These 
programs vary in terms of venue and duration; however, all Military 
Service programs must cover the same core topics to the level of 
competency necessary for first-term Service members to apply basic 
financial principles to everyday life situations.
    The Department has tracked the ability of Service members to pay 
their bills on time as a reflection of their competency and ability to 
apply basic financial principles. Since 2002, self-

[[Page 50581]]

reported assessments through survey data have shown Service members are 
doing a better job keeping up with their monthly payments.
    To assist the Military Services in delivering financial messages, 
the Department established the Financial Readiness Campaign in May 
2003, which has gathered the support of 26 nonprofit organizations and 
Federal agencies. In the past three years, Service members have 
benefited from the materials and assistance from over 20 active 
partnerships. These partnerships are on-going and have been developed 
to allow the Military Services to choose which partner programs can 
best supplement the education, awareness, and counseling services they 
provide. The materials and services supplement but do not take the 
place of the programs offered by the Military Services.
    Aspects of predatory lending practices are covered as topics in 
initial financial education training and in refresher courses offered 
at the military installations and aboard ships. The Military Services 
annually provide over 10,000 classes and train approximately 24 percent 
of the force, as well as nearly 20,000 family members. These classes 
are primarily conducted on military installations located in the United 
States.
    In addition to these classes, Financial Readiness Campaign partner 
organizations conduct over a thousand classes informing over 60,000 
Service members and family members per year. These classes are 
primarily provided by the staff of banks and credit unions located on 
military installations (military banks and defense credit unions). 
These institutions provide these classes as part of their 
responsibilities outlined in the DoD Financial Management Regulation. 
Other organizations involved include local Credit Counseling Agencies, 
State financial regulatory agencies, the InCharge Institute, and the 
NASD Foundation.
    The Military Service financial educators, along with partner 
organizations, also distributed over 200,000 brochures and pamphlets, 
with the Military Services and the Federal Trade Commission primarily 
providing these products. In addition, Military Money Magazine has run 
several articles, to include two cover articles on predatory lending. 
The magazine is free and is distributed through military commissaries, 
family support centers and other service agencies on the installation, 
as well as to residents on installation and to addresses off the 
installation upon request. The distribution is approximately 250,000 
per quarter.

Lending Practices Considered Predatory

    As identified in GAO Report 05-349, DOD's Tools for Curbing the Use 
and Effects of Predatory Lending Not Fully Utilized, April 2005, the 
review of practices that are considered predatory has not benefited 
from a consistent definition that has been universally applied. 
However, sources studying the issue of predatory lending have focused 
on similar characteristics. GAO Report 04-280, Federal and State 
Agencies Face Challenges in Combating Predatory Lending, January 2004, 
said the following:

    While there is no uniformly accepted definition of predatory 
lending, a number of practices are widely acknowledged to be 
predatory. These include, among other things, charging excessive 
fees and interest rates, lending without regard to borrowers' 
ability to repay, refinancing borrowers' loans repeatedly over a 
short period of time without any economic gain for the borrower, and 
committing outright fraud or deception.

    This definition has been reiterated in the FDIC Office of the 
Inspector General Audit Report 06-0111, June 2006, which stated:

    Characteristics associated with predatory lending include, but 
are not limited to, (1) Abusive collection actions, (2) balloon 
payments with unrealistic repayment terms, (3) equity-stripping 
associated with repeat financing and excessive fees, and (4) 
excessive interest rates that may involve steering a borrower to a 
higher-cost loan.

    These same characteristics were also identified in the DoD Report 
to Congress on Predatory Lending Practices Directed at Members of the 
Armed Forces and Their Dependents, August 9, 2006:

    Predatory lending in the small loan market is generally 
considered to include one or more of the following characteristics: 
High interest rates and fees; little or no responsible underwriting; 
loan flipping or repeat renewals that ensure profit without 
significantly paying down principal; loan packing with high cost 
ancillary products whose cost is not included in computing interest 
rates; a loan structure or terms that transform these loans into the 
equivalent of highly secured transactions; fraud or deception; 
waiver of meaningful legal redress; or operation outside of state 
usury or small loan protection laws or regulations. The effect of 
the practices include whether the loan terms or practices listed 
above strip earnings or savings from the borrower; place the 
borrower's key assets at undue risk; do not help the borrower 
resolve their financial shortfall; trap the borrower in a cycle of 
debt; and leave the borrower in worse financial shape than when they 
initially contacted the lender.

    While the Report to Congress provides a more expansive definition, 
there are several commonalities among the definitions listed above:
     Lending without regard of the borrowers ability to repay;
     Excessive fees and excessive interest rates;
     Balloon payments with unrealistic repayment terms;
     Wealth stripping associated with repeat rollovers/
financing; and
     Fraud and deception.
    The Department started collecting information on high cost lending 
in 2004 as part of the Defense Manpower and Data Center annual surveys 
of active duty Service members. The survey requested input on payday 
loans, rent-to-own, refund anticipation loans and vehicle title loans. 
GAO Report 05-359 focused on these four practices and obtained feedback 
from command leaders, Personal Financial Management (PFM) program 
managers, command financial counselors, legal assistance attorneys, 
senior noncommissioned officers (pay grades E8 to E9), chaplains, and 
staff from the military relief/aid societies. Data from these and 
others indicate that providers of such loans may be targeting Service 
members.
    The Report to Congress reviewed five products (payday loans, 
vehicle-title loans, rent-to-own, refund anticipation loans, and 
military installment loans) identified by installation-level financial 
counselors (employed as PFM program managers and employed by the 
Military Aid Societies) and legal assistance attorneys who regularly 
counsel service members on indebtedness issues. When compared against 
the common characteristics listed above, the five products reviewed in 
the Report to Congress measure up somewhat differently:

----------------------------------------------------------------------------------------------------------------
                                                             Without
                                                           regard for     Excessive    Unrealistic    Repeated
                     Lending product                       borrowers'     fees and       payment      rollover/
                                                           ability to     interest      schedule     refinancing
                                                              repay
----------------------------------------------------------------------------------------------------------------
Payday loan.............................................            X             X             X             X
Vehicle title loan......................................            X             X             X             X

[[Page 50582]]

 
Military installment loan...............................  ............            X   ............  ............
Refund anticipation loan................................  ............            X   ............  ............
Rent-to-own.............................................            X             X   ............  ............
----------------------------------------------------------------------------------------------------------------

    A major concern of the Department has been the debt trap some forms 
of credit can present for Service members and their families. The 
combination of little-to-no regard for the borrower's ability to repay 
the loan, unrealistic payment schedule, high fees, and interest and the 
opportunity to roll over the loan instead of repaying it, can create a 
cycle of debt for financially overburdened Service members and their 
families.
    Consumer groups, news media, and academics have chronicled concerns 
about payday loans and the propensity for this lending practice to 
create a cycle of debt. For example, M. Flannery and K. Smolyk state 
the following in their June 2005 FDIC Financial Research Working Paper 
No. 2005-09:

    Although as economists we find it hard to define what level of 
use is excessive, there seems little doubt that the payday advance 
as presently structured is unlikely to help people regain control of 
their finances if they start with serious problems.

    Likewise, vehicle title loans are similarly structured, with 
potentially similar results. According to a November 2005 report by the 
Consumer Federation of America, vehicle title loans are generally made 
for 30 days with high interest/fee structures (average of 295 Annual 
Percentage Rate (APR)). Limits on title loans vary by State concerning 
interest rates, duration, rollover allowances, and rules on 
repossessing the vehicle. Only four states cap interest rates at less 
than 100% APR. In many states these loans can be rolled over by the 
borrower several times if the borrower is unable to pay the principal 
and interest when due. If not paid or rolled over, many states allow 
the creditor to repossess the vehicle and in some states the borrower 
is not entitled to any portion of the proceeds of the vehicle sale. 
Loan amounts average 55 percent of the value of the vehicle.
    Rent-to-own, refund anticipation loans, and some military 
installment loans present products with high fees and interest. Rent-
to-own, which is not covered as credit under the Truth-in-Lending Act 
(TILA), can represent an expensive alternative to credit when used as a 
means of purchasing an item. Military installment loans (an installment 
loan marketed primarily or exclusively to the military) can represent a 
high cost over the duration of the loan, particularly when other 
charges are added to the interest rate. Tax refund anticipation loans 
(RALs) also cost Service members and their families high fees when they 
can easily obtain rapid returns through electronic filing with the 
assistance of their installation legal assistance office.
    According to the Consumer Federation of America (report dated 
February 5, 2007) the advantage of RALs is minimal when comparing the 
speed of the refund (between 7 and 14 days faster) against the cost of 
the service ($30--$125). Moreover, the APR for this credit can be 
triple digit. A study by Gregory Elliehausen of the Credit Research 
Center (CRC) (Monograph 37, April 2005) showed a 
disproportionate percentage of individuals under 35 years old use RALs. 
Sixty-one percent of RAL borrowers were below 35 years old, although 
individuals below 35 years old represent 28.6 percent of heads of 
households. This is significant since 79 percent of Service members are 
35 years old or below.
    The reason for using RALs vary. The CRC study showed that 41 
percent of borrowers obtain RALs to pay bills, 21 percent due to 
unexpected expenditures, 15 percent to make purchases, 15 percent 
because of impatience, and 7 percent for other reasons. Less than one 
percent said they obtained a RAL to pay for tax preparation. Through 
the Armed Forces Tax Council, in collaboration with the IRS, Volunteer 
Income Tax Assistance sites are located on most active duty military 
installations to assist Service members and their families with 
preparation and electronic filing of their tax returns.
    As with other forms of short-term, high cost credit, the Department 
would prefer Service members and their families to consider low cost 
alternatives to resolve their financial crisis by establishing a more 
solid footing for their personal finances. The CRC study found that 
users of RALs and payday loans both had similar levels of debt and 
patterns of credit use. Additionally, through education the Department 
attempts to persuade Service members that planning is an important part 
of managing finances, and a high cost 10-day loan does not reinforce 
this lesson.
    The five products reviewed in the Report to Congress represent two 
kinds of financial problems for Service members and their families: 
Those products that contribute to a cycle-of-debt (payday and vehicle 
title loans) and those products that can cost the military consumer 
high fees and interest costs (rent-to-own, installment loans and refund 
anticipation loans). Cycle of debt represents a more significant 
concern to the Department than the high cost of credit.
    The Department considered the five products in developing the 
regulation. Trade associations and financial institutions expressed 
their concern that the regulation needed to be very clear about when 
the provisions of the statute applied. During our consultation with the 
Federal regulatory agencies, they reiterated the need for ``clear 
lines'' around definitions of covered consumer credit and the impacted 
creditors.
    The regulation has focused on credit products that have, in general 
practice, terms that can be detrimental to military borrowers. Rent-to-
own services provide rental opportunities (not covered by the 
Department's rule making), as well as options for ownership which are 
not loans under TILA. As a consequence, rent-to-own products and 
services were not covered. Likewise, there are installment loans with 
favorable terms and some with terms that can increase the interest rate 
well beyond the limits prescribed by 10 U.S.C. 987. Isolating 
detrimental credit products without impeding the availability of 
favorable installment loans was of central concern in developing the 
regulation. Consequently, installment loans that do not fit the 
definition of ``consumer credit'' in Section 232.3(b), including the 
definition of ``payday loans,'' ``vehicle loans,'' or ``tax refund 
anticipation loans'' are not covered by the regulation. The 
Department's intent is to balance protections with access to credit. 
The protections posed in the statute assist Service members, when 
applied with precision to preclude unintended barriers.

[[Page 50583]]

Alternatives

    The Department prefers that Service members and their families who 
experience financial duress seek help through Military Aid Societies, 
military banks and defense credit unions rather than credit products 
that would more likely mire them in a cycle of debt. These institutions 
have established programs and products designed to help Service members 
and their families resolve their financial crises, rebuild their credit 
ratings and establish savings.
    The Military Aid Societies are strong advocates for limiting the 
cost associated with credit and for creditors to develop alternative 
products for Service members who cannot otherwise qualify for loans. 
Within their own resources they provided $87.3 million in no-cost loans 
and grants to Service members and their families in 2005. These funds 
were provided for emergencies and essentials, such as rent, food, and 
utilities.
    Financial institutions located on military installations also 
understand the need to provide products and services that can help 
those who mishandle their finances and who may need remedial 
assistance. A review of on-base financial institutions surfaced 24 
programs on 51 military installations in the U.S. providing alternative 
small loan products designed to help Service members and their families 
to recover from their financial problems. These financial institutions 
supplement the emergency funding made available by the nonprofit 
Military Aid Societies that provide grants and no-interest loans to 
needy Service members and families.
    These financial institutions provide low denomination loans at 
reasonable APRs designed to assist their members who need to get out of 
high cost credit and into more traditional lending products. Financial 
counseling and education are often prerequisites for the short term 
loans and some institutions have attached a requirement to develop 
savings as part of the loan.
    Many of these military banks and credit unions use their products 
and services to maintain a watchful eye over their members to ensure 
they do not abuse services designed to assist them, such as overdraft 
protection, which if used on a chronic basis, can become very expensive 
and propel someone already overextended into a deeper spiral of debt. 
Representatives of the Association of Military Banks of America had an 
opportunity to showcase their alternative small loan products at a FDIC 
Conference in December of 2006. FDIC hosted this conference to 
spotlight the need to develop more of these types of products for 
Service members and their families and several financial institutions 
described above that currently provide such favorable credit to Service 
members participated in the conference.
    Subsequent to the conference, FDIC issued guidelines to FDIC-
supervised banks to encourage them to offer affordable small-dollar 
loan products. These guidelines explore a number of aspects of 
developing alternative small loan products, including affordability and 
streamlined underwriting. They also discuss tools such as financial 
education and savings that may address long-term financial issues that 
concern borrowers.
    At the same time, the FDIC approved a two-year pilot project to 
review affordable and responsible small-dollar loan programs in 
financial institutions. The project is designed to assist institutions 
by identifying information on replicable business models for affordable 
small-dollar loans. FDIC expects to identify best practices resulting 
from the pilot that will become a resource for institutions. The 
Department supports the FDIC's efforts with the guidelines and the 
pilot project as they both will help encourage banks to meet the demand 
for small-dollar loans at more reasonable costs for the borrower.

Efforts To Curb the Prevalence and Impact of Predatory Loans

    The Department has found that it has a small window of opportunity 
to convince and inform Service families about products and services 
beneficial to their particular situations, a job complicated by many 
contrary messages and enticements. Nonetheless, the Department has 
attempted to use the processes and resources available within the 
Department to curb the prevalence of high cost short term lenders, 
particularly those that can contribute to a spiral of debt.
    Predatory lenders have seldom been placed off-limits, primarily 
because the process associated with placing commercial entities off-
limits, through the review and recommendations of the Armed Forces 
Disciplinary Control Board (AFDCB), is not well suited to this purpose. 
The AFDCB, covered by Joint Army Regulation 190-24, is designed to make 
businesses outside of military installations aware that their practices 
raise morale and discipline concerns and to offer these businesses an 
opportunity to modify their practices to preclude being placed off-
limits. When the commercial entity refuses to comply, the AFDCB 
recommends that the regional command authority place the business off-
limits for all Service members within the region (regardless of 
Service).
    Normally concerns are raised when a business has violated State or 
Federal laws. Remediation involves the business curtailing these 
illegal practices. In the case of the loan products listed above, 
businesses usually offer their services within the legal limits. Since 
the AFDCB takes on businesses one at a time, bringing a lender under 
scrutiny has been difficult if the lender is complying with the same 
rules as its competitors. Additionally, the magnitude of mediating with 
the number of outlets surrounding military installations has 
exacerbated the process. Numerous payday lenders can be found in 
communities around military installations (Graves and Peterson, Ohio 
State Law Journal, Volume 66, Number 4, 2005).
    Also without clear standards and prohibitions, commanders and 
AFDCBs cannot easily identify what remediation lenders offering payday, 
auto title, and refund anticipation loans should take. In states 
without relevant laws, Commanders and AFDCBs must not only establish 
rules, but they must also educate those affected and then monitor their 
compliance.
    As stated above, the Department will continue to provide education, 
awareness, and counseling programs to influence skills and attitudes 
towards managing personal resources wisely. There still remains a gap 
between the opportunity to influence a young Service member or family 
member concerning the best way to manage their finances, and the level 
of experience and capability necessary to be successful. The Department 
has a limited opportunity to impress upon these young people the 
importance of managing their resources. It does not have sufficient 
control over the behavior of Service members and their families to 
preclude them from taking on financial risks that can detract from not 
only their quality of life, but also military mission accomplishment.
    The Department will continue to send Service members messages that 
they and their families need to manage their resources wisely for their 
own benefit and to maintain personal readiness. The Department's call 
for responsibility competes with market messages from the sub-prime 
financial industry to get cash now for purchases, vacations, and paying 
bills. Their marketing stresses the ease and convenience of obtaining 
these loans, with a virtual guarantee of approval. These messages can 
be particularly alluring to Service members

[[Page 50584]]

and families already overburdened with bills and debts. A 2006 survey 
accomplished by the Consumer Credit Research Foundation concluded that 
Service members choose payday loans primarily because they are 
convenient. Certainly, obtaining ``fast cash'' from a payday lender is 
far easier than coming to terms with delinquent debt or addressing 
inherent overspending that creates situations where sub-prime loans are 
needed.
    Service members have inherently understood that limits on interest 
rates are appropriate, even if these limits would decrease the 
availability of credit. When asked in a 2006 survey conducted by the 
Consumer Credit Research Foundation if Service members strongly agree, 
somewhat agree or disagree with the statement: ``The government should 
limit the interest rates that lenders can charge even if it means fewer 
people will be able to get credit,'' over 74 percent of the Service 
members surveyed agreed with the statement (over 40 percent strongly 
agreed). Similarly when asked their position on the statement ``There 
is too much credit available today,'' 75 percent of Service members not 
using payday loans and 63 percent of Service members using payday loans 
agreed (51 percent of non-users strongly agreed).

``Limitations on Terms of Consumer Credit Extended to Service Members 
and Dependents,'' John Warner National Defense Authorization Act for 
Fiscal Year 2007, Section 670, Codified at 10 U.S.C. 987

    10 U.S.C. 987 directs the Secretary of Defense to establish and 
implement regulations concerning consumer credit services for Service 
members. Implementing regulations must be completed and published prior 
to October 1, 2007, after consultation with the Department of Treasury, 
Office of the Comptroller of the Currency, Office of Thrift 
Supervision, Board of Governors of the Federal Reserve System, Federal 
Trade Commission, Federal Deposit Insurance Corporation, and the 
National Credit Union Administration. Specifically, section 987(h)(2) 
requires the Secretary of Defense to issue regulations establishing the 
following:

    (A) Disclosures required of any creditor that extends consumer 
credit to a covered member or dependent of such a member.
    (B) The method for calculating the applicable annual percentage 
rate of interest on such obligations, in accordance with the limit 
established under this section.
    (C) A maximum allowable amount of all fees, and the types of 
fees, associated with any such extension of credit, to be expressed 
and disclosed to the borrower as a total amount and as a percentage 
of the principal amount of the obligation, at the time at which the 
transaction is entered into.
    (D) Definitions of ``creditor'' under paragraph (5) and 
``consumer credit'' under paragraph (6) of subsection (i), 
consistent with the provisions of this section.
    (E) Such other criteria or limitations as the Secretary of 
Defense determines appropriate, consistent with the provisions of 
this section.

    This broad latitude allows the Department to determine the scope 
and impact of the regulation, consistent with the provisions of the 
statute. These provisions have been established to protect Service 
members and their families from potentially abusive lending practices 
and products. The statute provides several limitations on credit 
transactions, and allows the Department to focus these limitations on 
areas of greatest concern.
    As noted in the preamble to the proposed rule, the Department has 
learned of the potential for unintended consequences that could 
adversely affect credit availability if it were to adopt a broadly 
applicable regulation. Some comments received suggested that one way to 
limit the potential adverse and unintended consequences of the statute 
would be to adopt a regulation that provided for a general or 
conditional exception for credit products offered by insured depository 
institutions and their subsidiaries. While the proposed rule did not 
include any exceptions for insured depositories or their subsidiaries, 
the Department explicitly asked for comment on the issue.
    Most respondents to the request for comments addressed the question 
of whether the final rule should exclude insured depository 
institutions from coverage generally or in limited circumstances. 
Almost all representatives of insured depository institutions strongly 
supported the Department exempting lenders that are subject to 
supervision by a Federal banking agency. They noted that these 
institutions have not been identified as engaging in predatory lending 
practices. Consumer representatives, on the other hand, as well as the 
FTC staff who provided comment on this issue, did not favor making 
distinctions in the ``creditor'' definition based on whether or not the 
lender was subject to supervision by Federal banking agencies.
    Comments from lending institutions about the need for a general or 
limited exemption of Federally-insured depository institutions and 
their subsidiaries from this regulation were tempered in part by their 
support of the proposed definition of ``consumer credit,'' which is 
limited to potentially abusive credit products identified by the 
Department in its report to Congress. Specifically, they noted that if 
the regulations were expanded to cover a wider range of financial 
products, the need for an exemption of insured depository institutions 
from this regulation would be increased to ensure that Service members 
and their dependents have access to affordable credit by responsible 
lenders.
    The intent of the statute is clearly to restrict or limit credit 
practices that have a negative impact on Service members without 
impeding the availability of credit that is benign or beneficial to 
Service members and their families. The Department has determined that 
given the limited types of credit products covered by the rule, an 
exemption for depository institutions is not needed to ensure access to 
beneficial credit by Service members and their dependents. Accordingly, 
the final rule does not provide exemptions for insured depository 
institutions or their subsidiaries. As noted above, Federally-
supervised financial institutions that commented appeared to be 
concerned about future iterations of the regulation and the potential 
for the regulation to impact their ability to provide beneficial credit 
to Service members and their families. If the Department considers it 
necessary to reconsider the products included as covered consumer 
credit, the issue of such exemptions would also be reconsidered.

II. Description of the Regulation, by Section

    232.1 and 232.2, Authority, purpose and coverage, and 
Applicability: No comments were received on these provisions. The 
provisions in the proposed rule are being adopted without substantive 
change.
    232.3, Definitions: In implementing the statute, the Department has 
defined the terms ``creditor'' and ``consumer credit'' judiciously, 
having heard from numerous groups through comments received in response 
to Federal Register notice DoD-2006-OS-0216, solicited and unsolicited 
comments, and through meetings requested of the Department that 
applying the provision broadly would create numerous unintended 
consequences. These unintended consequences would have a ``chilling 
effect'' on the availability of consumer credit for Service members and 
their dependents in circumstances that are not necessarily predatory.
    In defining the term ``creditor,'' the statute provides the 
following:


[[Page 50585]]


    (5) CREDITOR.--The term ``creditor'' means a person--
    (A) Who--
    (i) Is engaged in the business of extending consumer credit; and
    (ii) Meets such additional criteria as are specified for such 
purpose in regulations prescribed under this section; or
    (B) Who is an assignee of a person described in subparagraph (A) 
with respect to any consumer credit extended.

    Consistent with the statute, the final rule defines ``creditor'' as 
any person who extends consumer credit covered by part 232. For this 
purpose a ``person'' includes both natural persons as well as business 
entities, but would exclude governmental entities. Pursuant to the 
Department's authority to specify additional criteria, a person would 
be a creditor only if the person is also a ``creditor'' for purposes of 
the Truth in Lending Act (TILA). Section 987(c) of 10 U.S.C. provides 
that the disclosures required by that section be presented along with 
the disclosures required under TILA, and in accordance with the terms 
prescribed by the regulations implementing TILA. Thus, it does not 
appear that section 987 was intended to apply to persons or 
transactions that are not covered by TILA.
    For clarity, the Department has implemented the provision covering 
assignees by including a specific reference to assignees in each 
section of the regulation that would apply to an assignee, in lieu of 
including assignees in the definition of ``creditor.'' See sections 
232.4, 232.8 and 232.9.
    The definition of consumer credit provided in the statute is as 
follows:

    (6) CONSUMER CREDIT.--The term ``consumer credit'' has the 
meaning provided for such term in regulations prescribed under this 
section, except that such term does not include (A) A residential 
mortgage, or (B) a loan procured in the course of purchasing a car 
or other personal property, when that loan is offered for the 
express purpose of financing the purchase and is secured by the car 
or personal property procured.

    It is clearly the intent of the statute that the Department define 
which types of consumer credit transactions shall be covered by the 
law, provided that they do not include the two listed exemptions. This 
is because the statute authorizes the Department to specify additional 
criteria for an entity to be considered a creditor that is engaged in 
the business of extending consumer credit. The Department has exercised 
this authority by limiting the rule's applicability to creditors that 
engage in certain types of consumer credit transactions. Accordingly, 
the final rule focuses on three problematic credit products that the 
Department identified in its August 2006 Report to Congress on the 
Impact of Predatory Lending Practices on Members of the Armed Forces 
and Their Dependents: payday loans, vehicle title loans, and refund 
anticipation loans. The Department's definition of the term ``consumer 
credit'' in the proposed rule was intended to narrow the regulation's 
impact to consumer credit products and services that are potentially 
detrimental and for which there are DoD-recommended, alternative 
products or services available to Service members and their dependents. 
DoD believes that a narrow definition will prevent unintended 
consequences while affording the protections granted by the statute.
    After review of comments received through the Federal Register 
publication of the proposed rule, the Department believes that the 
scope of the regulation as proposed is appropriate to address the 
concerns that formed the basis of its report to the Congress. Comments 
received from consumer advocates and some others expressed the view 
that the Department's proposed definition of ``consumer credit'' was 
too narrow and that creditors could restructure their loan products to 
make high-cost extensions of credit while avoiding coverage under Part 
232. Comments received from representatives of federally-insured 
depository institutions generally supported the consumer credit 
definition in the proposed rule.
    The Department continues to believe that the scope of the proposed 
rule and the definition of consumer credit are appropriate. The 
Department maintains the ability to issue additional rules in the 
future and the Department plans to continue surveying Service members 
and their dependents to collect data on their use of credit products. 
The Department will also monitor market developments that affect 
Service members and will obtain a variety of inputs from regulatory 
agencies, consumer protection groups and the credit industry to assess 
the level of protection provided by the final rule. The Department will 
review this data to determine if further revisions are needed. 
Accordingly, the proposed definition of ``consumer credit'' is being 
adopted without substantive change. The Department has made technical 
changes to the regulation to clarify that the consumer credit defined 
in the regulation is closed-end credit and not open-end credit.
    With respect to exclusion of ``residential mortgages'' the final 
rule adopts the proposed rule's exclusion which applies to any credit 
transaction secured by an interest in the borrower's dwelling. Thus, 
home-purchase transactions, refinancings, home-equity loans, and 
reverse mortgages would be excluded. Home equity lines of credit are 
also excluded. In addition, the property need not be the consumer's 
primary dwelling to qualify for the exclusion. A ``dwelling'' includes 
any residential structure containing one to four units, whether or not 
the structure is attached to real property, and would also include an 
individual condominium unit, cooperative unit, mobile home, or 
manufactured home.
Payday Loans
    Payday loans have common characteristics that make them detrimental 
to a Service member's financial well being and inferior to alternative 
sources of emergency support. These characteristics can exacerbate a 
cycle of debt, particularly if the borrower is already over-extended 
through the use of other forms of credit. The final rule defines 
``payday loans'' based on certain characteristics, in order to 
distinguish them from other financial products. A payday loan is 
defined as a closed-end credit transaction having a term of 91 days or 
fewer, where the amount financed does not exceed $2,000. The ``amount 
financed'' is not defined in this regulation, but must be determined 
based on the definition of that term in the Federal Reserve Board's 
Regulation Z, which implements the TILA. In addition, the definition of 
``payday loan'' is limited to transactions where the borrower 
contemporaneously provides a check or other payment instrument that the 
creditor agrees to hold, or where the borrower contemporaneously 
authorizes the creditor to initiate a debit or debits to the covered 
borrower's deposit account.
    Payday loans, otherwise known as deferred presentment loans, are 
allowed in 39 States as a separate credit product from other forms of 
credit regulated by Federal or State statute. States authorizing these 
types of loans require payday lenders to obtain a license to operate 
within the State. States have defined these products and services, 
primarily through the basic process used to secure a payday loan, 
either through holding a check or by obtaining access to a bank account 
through electronic means. These basic processes have been included as 
part of the definition of payday loans in the regulation (Section 
232.3(c)). Many States have also established limits to the amount that 
can be borrowed and the duration of the loan as part of the authorized 
activities of lenders licensed to offer these products and services. A 
review of State limits for payday loans

[[Page 50586]]

establishes a foundation for the definition used in this regulation.
    The majority of States have a maximum dollar amount, maximum time 
limits and maximum fees that trigger regulation. Six States (New 
Mexico, Oregon, Texas, Utah, Wisconsin and Wyoming) have no dollar 
limit on the amount that can be loaned, and nine States (Alaska, 
Arizona, Idaho, New Mexico, Rhode Island, South Dakota, Virginia, 
Wisconsin and Wyoming) have no maximum limit established for the 
duration of a payday loan. Of the States that impose limits on the loan 
amount or loan duration, the highest dollar limit is $1,000 (Idaho and 
Illinois) and the longest permissible loan term is 180 days (Ohio). The 
average dollar limit is $519 and the average limit on loan term is 46 
days.
    Payday loans offered over the internet often originate in States 
with no limits on fees or maximum loan amounts. A survey of websites 
offering payday loans indicates $1,500 as generally the maximum amount 
loaned. A review of sites marketing ``Military Payday Loans'' refer to 
loans of up to 40 percent of a Service member's take home pay. This 
amount can vary considerably based on rank, other entitlements, tax 
withheld and military allotments. For married enlisted Service members 
in the grade of E-6 and below (no deductions for taxes or other 
allotments), the $2,000 limit in the final rule would cover a loan made 
for 40 percent of take-home pay. The limits established in the 
definition for payday loans reflect the maximum duration and amount 
anticipated for loans based on current State practices, to include 
internet payday loans originating from locations without limits.
    Many respondents expressed some concern that the four-part 
definition of payday loans may allow creditors to change one aspect of 
their product to evade the regulation, such as extending the length of 
the loan or extending open-end credit. The Department's intent is to 
balance these concerns against the concerns expressed by other 
respondents that the definition should remain as narrow as proposed to 
preclude unintended consequences regarding short-term, small-dollar 
credit availability for covered borrowers. Most financial institutions 
requested that the definitions of consumer credit clearly specify that 
they apply to closed-end loans to preclude misinterpretations.
    Industry and consumer group respondents requested clarification of 
the payday loan definition. Specifically, they sought to clarify that 
borrowers must provide a check to the creditor or authorize a debit to 
the borrower's deposit account contemporaneously with the borrower's 
receipt of funds, and not contemporaneously with the payment of 
interest or fees. Section 232.3(b)(1)(i) of the final rule has been 
modified to make this clarification.
    The definition of ``payday loans'' includes transactions where the 
covered borrower receives funds and contemporaneously authorizes the 
creditor to initiate a debit or debits to the borrower's deposit 
account. However, there is an exclusion to this definition in 
232.3(b)(1)(i)(A): ``This provision does not apply to any right of a 
depository institution under statute or common law to offset 
indebtedness against funds on deposit in the event of the covered 
borrower's delinquency or default.'' This exclusion only applies to a 
depository institution's right of offset under State or other 
applicable law.
Vehicle Title Loans
    The Department believes that vehicle title loans should be included 
within the definition of consumer credit, and that covering such 
transactions is consistent with the law's purpose. The definition for 
``vehicle title loans'' limits the rule's coverage to loans of 181 days 
or fewer. Many States have not established statutes overseeing these 
loans. A 2005 survey of States conducted by the Consumer Federation of 
America found that, of the 16 States authorizing vehicle-title lending, 
10 require 30-day or one-month term limits (with authorized renewals or 
extensions), and one State allows up to 60 days (with 6 renewals). Four 
States do not establish term limits.
    Some consumer groups remarked that the scope of the definition for 
vehicle title loans may not encompass all practices used by creditors 
to provide high-cost, short-term vehicle title loans. Some industry 
respondents said the restrictions in the regulation may make some 
creditors reluctant to offer beneficial loans to covered borrowers with 
poor or no credit history. However, the majority of federally-insured 
depository institution respondents said that their loans that use 
vehicles as collateral would be unaffected since they are made for 
longer than 181 days.
    As with payday loans, the Department has sought to balance the 
definition of vehicle title loans to reflect the countervailing 
concerns of respondents. The Department does not want protections from 
high-cost, short-term vehicle title loans to unnecessarily inhibit 
covered borrowers from accessing beneficial loans for which a vehicle 
is used as collateral.
    Comments received from a group of bank trade associations asked 
that the rule clarify that ``motor vehicle'' only includes vehicles 
which must be registered pursuant to state law. The final rule has been 
modified to make this clarification.
Refund Anticipation Loans
    The Department believes that covering RALs is consistent with the 
intent of the statute. They have been included because survey data has 
shown RALs to be the second most prevalent high cost loan used by 
Service members, and because alternatives that can expedite their tax 
returns are available, generally at no cost. Some states have also 
addressed concerns with RALs. Connecticut has established a rate cap 
for RALs, prohibiting transactions where the APR exceeds 60 percent. 
Other states, such as California, Washington, Oregon, and Nevada, have 
established statutes specifying disclosure requirements for RALs. 
Respondents representing tax preparers and financial institutions 
providing RALs objected to being included in the definitions of covered 
consumer credit products, stating their product does not contribute to 
a cycle of debt or place a critical family asset at risk.
    Credit union trade association respondents and bank trade 
association respondents said the inclusion of RALs in the rule would 
have little impact on their members because so few of them make these 
loans, and the few that do make them will likely cease doing so because 
of the rule's requirements. The Department believes that its definition 
of RALs limits unintended consequences and allows for refunds to be 
provided expeditiously.
    One commenter expressed concern that the rule could be construed to 
apply when a borrower notes that the source of repayment is the tax 
refund. The intent of the regulation is to cover credit products that 
are designed expressly to use tax refunds as the collateral for the 
loan. The rule does not cover loans where borrowers merely note that a 
tax refund may be used to repay the advance. To ensure the Department's 
intent is clear, the word ``expressly'' has been repeated in the RAL 
definition to modify the statement concerning repayment of the loan.
Loans Where the MAPR Is Less Than 24%
    In its proposal the Department solicited comments on other 
approaches that would encourage lenders to offer responsible, small-
dollar, short-term loans that meet the credit needs of Service members 
and their dependents. For example, comment was solicited on whether 
loans should be exempt from

[[Page 50587]]

coverage under Part 232 if the MAPR were less than 24%.
    Industry respondents generally said that such an exemption would 
have little impact on credit products defined in the regulation because 
the credit product definitions are already narrow enough in scope to 
leave institutions room to provide affordable small-dollar loans to 
Service members and their dependents. Some consumer groups favored such 
an exemption only if it were part of a ``safe harbor'' accompanied by 
significantly broader definitions of covered credit products. The 
Department has not adopted an MAPR-based exemption from the definition 
of consumer credit in the final rule to include this recommendation. To 
accommodate current and potential small-dollar, short-term loan 
programs, the Department has already made allowances in the regulation 
for credit products that are within the MAPR limit of section 232.4(b) 
and believes these are sufficient to support lower cost alternatives.
Definition of MAPR
    The definition of MAPR creates a distinctive percentage rate that 
reflects the provisions of the statute. The MAPR does not include fees 
imposed on the borrower for unanticipated late payments, default, 
delinquency or a similar occurrence, because such fees are imposed as a 
result of contingent events that may occur after the loan is 
consummated. Thus, such fees are not included in the computation of the 
maximum 36% MAPR cap imposed by these rules.
    Many respondents expressed concern that disclosing both an MAPR and 
an APR to Service members and their dependents would cause confusion. 
The statute requires that the MAPR be presented to the covered 
borrower. The Department will take steps to educate Service members and 
their dependents on the MAPR.
    While acknowledging that the narrow scope of the rule will ease the 
potential for confusion, comments from industry representatives sought 
to modify the MAPR definition to make it as close as possible to the 
APR disclosed under TILA. By contrast, consumer groups contended that 
the MAPR definition should include all cost elements, and should not 
contain exclusions in the proposed rule, such as for actual 
unanticipated late payments.
    The Department has designed the definition of MAPR within the 
context of the consumer credit covered by the regulation. The 
Department's intent is to ensure that the credit products covered by 
the regulation cannot evade the 36 percent limit by including low 
interest rates with high fees associated with origination, membership, 
administration, or other cost that may not be captured in the TILA 
definition of APR.
    Some industry respondents were concerned about including costs in 
the MAPR that are ``associated with the extension of consumer credit'' 
because this may include costs for products or services that are 
purchased in connection with a loan, but are not required. For example, 
industry respondents argue that ancillary products (such as voluntary 
credit insurance and debt cancellation coverage) should not be included 
in the MAPR calculation because these products may protect borrowers 
against being burdened with debt if a covered event occurs.
    The Department believes the definition is consistent with the 
statute and is appropriate in the context of the consumer credit 
covered by the rule. The Department is concerned that Service members 
are sold products such as voluntary insurance without having these 
credit insurance products placed in the context of the Service member's 
employment status or his or her current level of insurance coverage. 
Additionally, the Department is concerned about small loans that are 
associated with sales of products or services not related to the loans, 
such as credit offered as part of Internet access or catalog sales. The 
definition has been designed to cover sales such as these or sales 
similar to those mentioned in this paragraph and considers them 
``associated with the extension of consumer credit.''
    One commenter expressed concern that only fees for ``actual 
unanticipated'' late payments would be excluded from the MAPR, because 
some borrowers might notify the lender if they know their payment will 
be late. The language in the proposed rule tracks the language in 
section 226.4(c)(2) of Regulation Z, which excludes such fees from the 
APR disclosed under TILA. The intent is to exclude charges from the 
MAPR that the lender does not anticipate under the terms of the 
agreement. The language in the final rule is being adopted as proposed, 
so that creditors determinations under Part 232 will be consistent with 
their existing practice under TILA.
    The final rule also has been revised to clarify that the MAPR does 
not include certain taxes or fees prescribed by law, such as fees paid 
to public officials in connection with perfecting a security interest. 
See Sec.  232.3(h)(2)(i) and (ii). The revision is being made for 
consistency with the Federal Reserve Board's Regulation Z, which does 
not require such charges to be included in the APR disclosed under 
TILA.
    Industry respondents also requested that the final rule clarify 
that the definition of ``consumer credit'' be limited to closed-end 
transactions so that the rules are not unintentionally interpreted to 
include credit cards. Many respondents stated it was not clear whether 
the rule included open-end credit and that it is important that the 
final rule explicitly state it is limited to the three listed closed-
end credit products. In order to clarify that the regulation covers 
only closed-end credit, the definition in 232.3(b) has been modified to 
include the words ``closed-end'' as part of the definition of covered 
consumer credit.
    232.4, Terms of consumer credit extended to covered borrowers: This 
section implements the statutory prohibition limiting the amount that 
creditors may charge for extensions of consumer credit to covered 
borrowers. The proposed rule mirrors the statutory language. This 
section also applies to ``assignees'' consistent with the statutory 
definition of ``creditor.''
    232.5, Identification of covered borrower: The Department has 
received several comments expressing concern over the potential 
difficulty in identifying a covered borrower, particularly in light of 
the penalties for failing to provide the statutory protections to a 
covered borrower. While the Department recognizes this concern, the 
Department would emphasize that identifying the covered borrower is 
only relevant in the context of transactions defined by the regulation 
as consumer credit (for payday loans, vehicle title loans and refund 
anticipation loans).
    Some respondents expressed concern that imposing a duty on 
creditors to identify dependents of active duty Service members in 
order to comply with Part 232 would conflict with the Equal Credit 
Opportunity Act, which is implemented by the Federal Reserve Board's 
Regulation B. These respondents noted that under Regulation B, a 
creditor may not inquire about a credit applicant's marital status. The 
Department notes, however, that the final rule does not require 
creditors to inquire about marital status. The ``covered borrower 
identification statement'' contained in Sec.  232.5(a) of the final 
rule requests credit applicants to identify if they are a dependent 
based on any of the listed criteria (spouse, child or individual for 
whom the member provides financial support), but

[[Page 50588]]

does not require an applicant to specify which one of these applies in 
their specific case. Accordingly, the ``covered borrower identification 
statement'' does not inquire about an applicant's marital status. The 
Department also notes that Sec.  202.5(a)(2) of the Federal Reserve's 
Regulation B states that creditors may obtain information required by 
federal statutes or regulations. The Department has consulted with 
staff of the Federal Reserve Board, and they agreed with the 
Department's analysis.
    The Department's intent is to balance protections for covered 
borrowers (according to the statute) while also addressing creditors' 
need to have some degree of certainty in determining that the loans 
they make are in compliance with the statute as implemented by Part 
232. The Department understands creditors may otherwise decline 
offering beneficial credit products to covered borrowers as a result of 
concerns over potential violations. To achieve an appropriate balance, 
the Department has proposed a safe harbor, under which the creditor may 
require the applicant to sign a statement declaring whether or not he 
or she is a covered borrower (using the definition from the statute). 
If required by the creditor, this declaration provides a ``safe 
harbor'' for the creditor to prevent inadvertently violating the 
statute by failing to recognize a covered borrower. For creditors who 
provide consumer credit, as defined by the regulation, by means of the 
Internet, the applicant can provide an electronic signature that 
fulfills the requirements of the Electronic Signatures in Global and 
National Commerce Act, 15 U.S.C. Sec.  7001 et seq.
    There is one caveat to this ``safe harbor'' provision. If the loan 
applicant signs a declaration that denies being a covered borrower, but 
the creditor obtains documentation as part of the credit transaction 
reflecting that the applicant is a covered borrower (such as, a current 
military leave and earning statement as proof of employment), the 
applicant's declaration would not create a safe harbor for the 
creditor. In such cases, creditors should seek to resolve the 
inconsistency, but if they are unable to do so, they may avoid any risk 
of noncompliance by treating the applicant as a covered borrower based 
on the documentation or by declining to extend credit due to the 
inability to verify information provided in the borrower's signed 
declaration.
    This caveat prevents creditors from using the declaration to allow 
covered borrowers to waive their right to the protections provided by 
the regulation. This may occur when the creditor recognizes the 
applicant is a covered borrower as a result of the documents presented 
as part of the credit transaction. The intent of this caveat is not to 
hold the creditor accountable for false statements made by an applicant 
when there is no indication through the credit transaction that the 
applicant is a covered borrower.
    In contrast, when an applicant claims to be a covered borrower 
without presenting proof of status, further validation by the creditor 
is not required. However, creditors have the option of verifying the 
applicant's status as a covered borrower using several sources of 
information, but they are not required to do so. Thus, creditors may 
request applicants to provide proof of their current employment and 
income, for example by requesting from service members a copy of the 
most recent month's military leave and earning statement. Creditors may 
also request Service members or dependents to provide a copy of their 
military identification card.
    These sources, however, might not always be determinative. For 
example, in some cases a leave and earnings statement might not reflect 
a recent change in the applicant's active duty status. Military 
identification cards, which are the same as identification cards 
carried by members of the active component, are issued to members of 
the National Guard and the Reserve regardless of their duty status. 
Hence, the final rule states ``[u]pon such request, activated members 
of the National Guard or Reserves shall also provide a copy of the 
military orders calling the covered member to military service and any 
orders further extending military service.'' This would also be the 
case for their dependents. The final rule does not provide a safe 
harbor to creditors in the situation described in this paragraph.
    It is the Department's understanding that providing proof of 
employment