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What Happened to Truth-in-Lending?

posted by Elizabeth Warren

Professor Lynn LoPucki sent this email, which I pass along with his permission. Perhaps someone will want to answer his question.

Last  month I was a little short of cash, so I left $3,000 on my credit card balance. The bill I got today shows a finance charge of $122. Citibank states that the APR is 14.49%, but by my calculation, the rate charged is 48.8%.

They apparently get their number by multiplying last month’s entire bill – not the amount left on the bill – by the APR. But (1) I didn’t have the whole amount outstanding for the entire month and (2) they don’t charge any interest at all if I pay the entire bill on time.

As I recall, a main purpose of the Truth in Lending Act was to make interest rates comparable by requiring that they call be calculated in the same manner – one that reflects as nearly as possible the true cost of borrowing.  Where exactly did that purpose go astray?


This can happen because of double-cycle billing, or some variation on it. The finance charge each month depends not only on the APR but also on the balance calculation method. Some card issuers calculate the finance charge based on a balance from the prior billing cycle. The Federal Reserve has a proposed rule http://www.federalreserve.gov/newsevents/press/bcreg/20080502a.htm that would ban double-cycle billing, among other things. The double-cycle billing ban is one of the less controversial parts of the proposed rule on unfair credit card practices. The APR is not a good indicator of the cost of credit cards, partly because of balance calculation and payment application rules, and also because it excludes many fees that are routinely imposed.

No card company calculates interest the way this person thinks, and "truth in lending" means nothing if a person won't read the credit card agreement which is on the reverse side of her bill.

Most companies accrue interest daily. If a customer pays the full bill within the grace period, that interest is forgiven for the period's new charges. She did not pay the full bill; so she had to pay the interest on the money which they had advanced to her during the previous month for her purchases. She will find more interest for the $3000 on the next bill, because she will have borrowed the $3000 for an additional month by then. She can minimize future interest charges by making an early payment as soon as possible, if her card allows it.

There is a recent trend among lenders to arbitrarily reduce previously approved credit limits and notify the borrower some time after the fact.

While that understandably reduces the lenders exposure to default liability it artificially inflates the borrowers debt ratio.

One important consideration in developing a credit score is the ratio of the amount of credit a person has been authorized verses the amount they have actually used. If a person has a credit limit of $10,000 and they have only used $5,000 then they look pretty good. However, if the bank suddenly reduces their previously authorized limit to $5,000 then that person is instantly maxed-out and that reduces their score and impacts their ability to obtain loans, and it effects interest rates on loans which are score-sensitive…and that’s’ just not good (unless you are a bank).

This appears to happening on such a broad scale in reaction to the bubble bursting on years of questionable lending practices. Impacting that broad a spectrum of the public has a corresponding detriment to the nations credit standards.

I have no argument with lenders attempting to rectify their credit-crack practices. But their efforts to cram the genie back into the bottle are harming people who have already been put in danger by the economy.

POSSIBLE avenues to address (perhaps not resolve) the issues MIGHT include a temporary freeze on interest rates to 5% above prime for secured loans, 10% over prime for non-secured loans…that protects both sides. Freeze credit line REDUCTIONS, or at very least require lenders to give 6 months notice to borrows of their intent to reduce authorized credit limits. Establish federal fair-lending credit criteria to minimize loan-sharking and default potential.

If the government is looking for opportunities to maximize the benefit generated by their infusion of funds, perhaps it could ALSO consider shoring-up the foundation of the economy (the consumer) rather than merely trying to hoist it by the eaves (the lenders who arguably created the problems). If we are writing huge checks, consider absolving student loans, and consider absolving medical debt. These two categories constitute enormous debt for the youngest and the oldest strata of the population who have the least resources for re-payment.

It is a multi faceted problem that will require a multi faceted solution that will be uncomfortable to all but should not be devastating. But lenders should not be allowed to pull the rug out from under unsteady borrowers by arbitrarily reducing credit limits. At least that’s my opinion. Thank you for your consideration of the subject.

Paul - I am one of those 'wonky' types who reads everything from the credit card lender very carefully yet I was startled to find a similar interest charge last summer due exactly to that 'double-cycle billing' practice as described by AW above. (I rarely carry a balance) Even stranger was that the balance they calculated the interest on in no way matched any of the balances shown on the statement nor could the first rep I spoke to explain why this was so! The real stunner came on the next month's bill - although I carried a balance over two billing cycles, at the the end of the second cycle I paid off the balance. Yet on the next month's bill there was still an interest charge. Next time that particular lender (BofA) pulls this crap I will cancel the card and blister a few ears on the way out.

Following up a bit on Alan White's accurate comment, Prof LoPucki may want to review a few sections of Regulation Z at 12 CFR 226, the rule promulgated by the Federal Reserve Board to implement TILA, as well as the Official Staff Commentary to the regulation (which carries the force of law). These two items provide a detailed explanation of how finance charges are to be calculated by card issuers, and are used extensively by programmers who have designed the systems used to perform the calculations and the statements received by customers.

Specifically, he should section 226.7(e) and the pertinent Commentary. It might also be useful to peruse Appendix G for a sense of how card issuers are required to disclose specific mathematical calculation methods to the customer.

Citi is well known in the industry as using the two-cycle balance calculation method.

I'm just curious:

"As I recall, a main purpose of the Truth in Lending Act was to make interest rates comparable by requiring that they call be calculated in the same manner...."

Why do you believe that?

Sorry to be cynically accurate, but the purpose of legislation in lending is to make sure the regulations do not interfere with the orderly function of the credit market.

I read far beyond a 5th-grade level. Nevertheless I am quite confused reading the current 'truth-in-lending' disclosures from BofA & others. Per my comment ( http://www.creditslips.org/creditslips/2008/10/what-happened-t.html#comment-136226717 ) on a recent post, may I remind you folks that the BofA representative I contacted was unable to explain where exactly the balance that the interest I owed was calculated from - perhaps BofA's employees lack the necessary reading chops? While it's certainly true that I can absent our household from the current abusive practices of card lenders like BofA by canceling our accounts, that is not good enough - how can I hurt these people financially? I've had quite enough of their dishonest, abusive tactics and they need to feel the pain I've been made to feel. Or are we common folks mere peons worth only of exploitation w/them feeling no fear of retribution save that of the 'tar & feathers' model, a model highly unlikely in these days of nationalized banks & heavily militarized police forces?

Gee Ms Warren, it's not that complicated. You borrowed a lot more than $3,000 (about $10,000, in fact) for as long as 60 days (30 day cycle plus 30 day grace period).

For this two month loan you would have paid no interest at all. However, you decided that you didn't want to pay it back. Accordingly, the creditor charged you the contracted interest rate for the entire amount of the loan, EXACTLY AS HE SAID HE WOULD WHEN YOU SIGNED UP FOR THE REVOLVING CREDIT ACCOUNT.

Now, I know you're playing dumb with this, but it's not that complicated. Lenders aren't in this business for charity. Either pay it all back, or pay interest on it all.

The contract was written in English for a reason. That you don't like the terms is a reason to cut up the card, not to deny the rest of us our own choice.

"[Now, I know you're playing dumb with this, but it's not that complicated. Lenders aren't in this business for charity. Either pay it all back, or pay interest on it all.]"

I pretty she has a legal background so she can understand your point but I think that she's writing to an audience which doesn't know anything about contracts and feels that they're victims.

Hopefully Barack Obama will give the working poor more than lip service and stand behind his campaign line that work should be rewarded again in this country. But, most likely, he's pandering to sentimentality like Ms. Warren is.

It would be great if someone could come up with an online tool that would incorporate the various methods of calculation used by different companies, and let people put in numbers -- amount owed, crucial dates -- and see what happened to their balance if they paid a specific amount as of a specific date.

I'd be surprised if it could even be done. THAT would be comparability.

You'd have to get a good programmer, and invite people to send in copies of their card contract paperwork and numbers, and come up with a model that matched them.

Know anyone at a university where there might be someone who could do that as a grad level thesis project? It'd be fascinating.

As I recall the "terms" have to be made available for people to compare -- but you only see the full terms when you're about to sign the piece of paper, and you can't take that term sheet and go elsewhere, get another credit card company's terms, and line them up side by side to compare them. By the time you did, your "offer" will have "expired" and your next one may have different terms.

But it hardly matters since they can change your terms by sending you a notice in the mail, like it or lump it.

Of course to do it 'right' you'd have to factor in how long it takes to get your check through the mail system. Remember, if you live in Maine, your payment address is somewhere in rural Nevada, and if you live in Nevada, your payment has to get to some little town in rural New Hampshire. Those delays add to your costs.

I read this post with interest becuase the same economic result has happened to me and I wondered if Profs Lopucki and Warren were on to something I had missed.

I hope to say this more nicely than "some jarhead" did, but having read this post and the back of my B of A bill, I come to the conclusion that this post only shows - much to my surprise - that the good professors do not understand how their credit card works and frankly it undermines their professional authority to display that publicly. The b of a statement is clear in one place ("Grace Period") that, if you pay your balance in full by the due date for a billing cycle (which I will call Cycle 1 for clarity), they don't charge you any interest at all for that billing cycle. Please keep in mind that the due date for Cycle 1 falls in the next cycle (which I will call cycle 2). Across the page, they tell you that if you don't pay the Cycle 1 bill in full by the due date, then in your next statement (for Cycle 2), you will get a finance charge interest for the daily unpaid balance in BOTH Cycle 1 old cycle and Cycle 2.

So I don't see any Truth in Lending problem here. I see a comprehension problem which many Americans have about finance, and I also see a quizzical lack of judgment on the part of two professors in suggesting moral improprieties on the internet when it is their lack of ability to fully comprehend legal language and financial concepts that is the cause of their state of surprise.

Bank of America called me a liar.

I had a credit card with Fleet Bank which was taken over by B of A. One month
after the takeover, I had a card balance of $25 and change. Usually I don't
pay until near the due date but this balance was small and so I paid it about
ten days early. Five days after the due date, I got a telephone call from B of A
collections threatening me with legal action if I did not pay. I was certainly
confused but then remembered that the bill had been paid and said so. When I
asked the collection agent what date was on the check, she told me I had paid
late and put a false date on the check. I'm not sure how she knew there even
was a check if her story was that the bill had not been paid. Anyway, I
received these calls for three days in a row, all threatening action over
an already paid balance and all extremely rude, including the contention that
they could and would call me with threats anytime they wanted to until I
paid. After a long time on the phone with B of A (another department) I got
them to recognize *their* problem, correct the account and stop the calls.

But they did the same thing the next month. After getting it straightened out
and closing the account I got a final statement with zero balance. Inside was
a message from a top executive which was one of the most anal business
communications I have ever seen. In essence it said, "We might have made a
few small errors on some accounts but don't worry because your account is
safe with us". This was sloppily written, sloppily printed, rude and
unapologetic. It looked like mimeograph (remember those). For what they did
to me, I should have had a personal apology from the CEO, typed by a secretary
on cream vellum, personally signed with a fountain pen and delivered by
a courier on horseback accompanied by trumpet flourishes. But no.

Bank of America will never again get any of my financial business, nor will
any of their divisions or acquired companies.

I think it is amusing that the comments above on how Professor LoPucki did not read the contract all use the pronoun "she" to refer to LoPucki.

Perhaos, SomeJarhead, the post should have been written in English?

Why we are facing bankruptcy? Who to blame for this bad result of financial operations? Do we think lending institutions including creditor and debtor are having faults and illegal financial transactions? I believe this is an unfair judgment due to the fact that those who are applying for the loans are adults who can and should be making responsible financial decisions. Borrowing money when you cannot afford to pay it back is the fault of the borrower, not the lender. If someone fails to meet the terms of their contract by defaulting on their loan and accrue additional late penalties, which then drive the borrower into further debt that they may not be able to pay off, should not be blamed on the payday loan industry. Research by Vanderbilt Law School Assistant Professor Paige Marta Skiba found that applicants that were approved for payday loans were more likely to file bankruptcy than those who did not. This seems to be a mute argument in the sense that those who are applying for the loans are applying because they need money. People who don't need money don't apply! People headed towards bankruptcy are those who naturally have a tendency to both need money and spend it irresponsibly and therefore are more drawn to apply for money that may be easier to qualify for. Payday loans have minimal qualification criteria making them a good target for those that are less credit worthy. The bottom line is--it is unfair to blame the lender for the borrower's irresponsibility.

I had this happen to me with Citi World MasterCard this month. I got hit with double cycle and residual interest billing. I left an $80 balance on my credit card (out of an outstanding balance of 3131$). Because I didn't pay the $80, I was charged interest on the 3131$ & interest on the next month's balance as well. The $80 balance meant that I lost the 30 grace period on my next billing cycle. The second month the bill was paid in full, but I did not have a grace period on that bill, so was paying interest on my average daily balance from the drop of the billing cycle. But because I left $80 on one bill, I was charged interest on two bills. That $80 ended up costing me an additional 24.50 & 22.83 or 49.33-almost 50%.

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