|Adverse action clarified (September 2007)|
Confused about Reg B’s adverse action requirements? Here’s a detailed explanation.
Bankers see new possibilities with method that mixes old code and new
The May Mailbox contained a question titled, “Can’t act adversely if you don’t sell what the customer wants.” The question addressed Regulation B [12 CFR 202.2(c)(iv)] and adverse action. The question asked if the bank was required to provide an application to a potential applicant inquiring about a seven-year car loan where bank policy did not allow amortization to run that long. We stated that the bank could simply inform the customer that this was not a “type” of credit offered, and not supply an application or provide an adverse action notice. A clarification is in order.
This question and answer blend two separate parts of the Reg B analysis: 1. when an inquiry becomes an application, and, 2. differentiating between type of credit and terms of credit when determining if an adverse action notice is required.
What actually happened?
First, one needs to decide whether the scenario presents an inquiry or an application. Only after there has been an application does the adverse action issue turn on whether the denial has to do with a “type” of credit you do or do not offer.
The Regulation B Commentary recognizes that applicants often seek information before deciding to apply. This is the “shopping phase” of the loan process, when the applicant will generally inquire about rates, terms, product availability, and collateral. The commentary gives examples of “inquiries” that are not “applications.” Among the examples are cases when a consumer calls to ask about loan terms and an employee explains the creditor’s basic loan terms, such as interest rates, loan-to-value ratio, and debt-to-income ratio, or when a loan officer only explains to a prospective homeowner the creditor’s loan-to-value ratio policy and other basic lending policies, without telling the consumer whether he or she qualifies for the loan.
At the “inquiry stage,” answers to questions about the terms of credit do not require a lender to give an adverse action notice to the borrower, unless the lender treats the inquiry as an application, as discussed below. Informing a borrower that a seven-year car loan is not offered by the bank is not adverse action at this phase of the process. Most consumers have no interest in filling out an application for something the bank doesn’t offer.
An inquiry becomes an application when the creditor evaluates information about the consumer, decides to decline the request, and communicates this to the consumer. In that case, the creditor has treated the inquiry as an application and must then comply with the notification requirements under Sec. 202.9. Whether an inquiry becomes an application depends on how the creditor responds to the applicant, not on what the applicant says or asks.
The commentary to §202.2(c)(2)(v)1 states that when it comes to adverse action, there is a difference between terms of credit versus type of credit offered. It states that when an applicant applies for credit and the creditor does not offer the credit terms requested by the applicant (for example, the interest rate, length of maturity, collateral, or amount of down payment), a denial of the application for that reason is adverse action (unless the creditor makes a counteroffer that is accepted by the applicant) and the applicant is entitled to notification under §202.9.
Exploring the implications
Consider the following two scenarios. In each scenario, a consumer walks into the branch and asks if the bank makes used-car loans. You say that you do.
In the first scenario, the consumer asks for an application in order to apply for a loan to purchase a 1975 AMC Gremlin. Your bank’s policy is that it only makes used-car loans for cars not more than seven years old. You inform the consumer of this, and the consumer leaves the bank without taking an application form. Is an adverse action notice required?
No, because the consumer simply made an inquiry about obtaining credit on terms not offered by you, but never applied for credit on those terms.
In the second scenario, the consumer asks for an application and takes the application without further discussion. When the applicant returns the completed application to you, you realize that the application is for a 1975 AMC Gremlin. Your policy is that you only make used car loans for cars not more than seven years old. Is an adverse action notice required?
Yes, in this case, because this application is for credit secured by collateral that you do not accept. Thus, the situation changes when a consumer makes an application. This is the point at which the commentary makes a distinction between types of credit and terms of credit. Indeed, the first words of the commentary to §202.2(c)(2)(v)1 state “[w]hen an applicant applies for credit and the creditor does not offer the credit terms requested by the applicant . . .”
In this second scenario, an adverse action notice, or a counteroffer, would be necessary because the bank has received a completed application from an applicant and denied the application for the reason that the creditor does not offer the credit terms requested by the applicant. The bank must either send an adverse action notice stating the reason for denial is that the bank only offers used car loans for cars not less than seven years old, or make a counteroffer.
Or consider the following example. Suppose that the applicant applies for credit to purchase a 2005 Mercedes, but asks for a seven-year term in the completed application he submits. Because we are in the application phase and the length of loan maturity is a “term” of the loan, an adverse action would be required.
Alternatively, the bank could make a counteroffer for a length of loan maturity term that the bank does offer—say a 48-month loan.
Another angle on the issue
So what is a “type” of credit where an adverse action is not required? Take our scenario one step further and when the customer returns the application he asks for a home equity line of credit (HELOC) to finance the purchase of the 2005 Mercedes. Your bank does not make any HELOCs. In this case, an open-end, residential real estate secured loan would be considered a different type of loan, not just a different term of the loan. No adverse action notice would be required to comply with Reg B. However, as a matter of sound business practice, you would inform the applicant that HELOCs are not offered by your bank.
Remember that when implementing the distinctions in the regulation, you must be careful that bank employees do not discourage applicants. Many banks find it easier to instruct front-line customer staff to be helpfully informative, but to be willing and open to take any application from any interested potential borrower.
Even during the inquiry stage of shopping, information can be provided by the customer that complicates the compliance process and can cause the situation to inadvertently cross the line from inquiry to “application” even though no formal paperwork has been completed. Therefore, make sure you have a process that works in the real world of customer interaction, and one that employees can be trained to implement in a compliant manner. BJ
The electronic version of this article available at: http://lb.ec2.nxtbook.com/nxtbooks/sb/ababj0907/index.php?startid=56
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