Written by Benjamin M. Litchfield, Regulatory Compliance Counsel
Happy Monday to all of you out there in regulatory compliance land. We have recently received questions about whether refinance transactions are exempt from the U.S. Department of Defense’s (DoD) revised Military Lending Act Rule (MLA Rule). There appears to be some confusion regarding some of the terminology used in the MLA Rule as well as some ambiguous provisions of state secured finance laws. The short answer is that refinance transactions are likely not exempt from the MLA Rule and credit unions will likely be required to comply with the rule’s requirements when refinancing a loan made to a covered borrower.
Section 232.3 of the MLA Rule defines “consumer credit” as “credit offered or extended to a covered borrower primarily for personal, family, or household purposes” that is also subject to a finance charge or payable in more than four installments. See, 32 C.F.R. § 232.3(f)(1)(i)-(ii). This section also sets forth a few exceptions to that definition including exceptions for residential mortgages, transactions exempt from Regulation Z and certain transactions “expressly intended to finance the purchase” of personal property or a motor vehicle “when the credit is secured by” the property or vehicle being purchased. See, 32 C.F.R. § 232.3(f)(2)(i)-(v). Some have argued that this last exception includes refinance transactions because those transactions qualify as “purchase money security interests” under state secured finance laws.
There is some support for the position that Section 232.3(f)(2) can be interpreted to exclude “purchase money security interests.” In the original MLA Rule, the DoD defined “consumer credit” to mean payday loans, vehicle title loans, and tax refund anticipation loans. A “vehicle title loan” was defined as “credit with a term of 181 days or fewer that is secured by the title to a motor vehicle, that has been registered for use on public roads and owned by a covered borrower, other than a purchase money transaction described in paragraph (b)(2)(ii) of this section.” See, 32 C.F.R. § 232.3(b)(1)(ii). The purchase money exception in paragraph (b)(2)(ii) is the same exception found in the current rule in paragraph (f)(2)(ii).
The DoD did not devote much discussion to this exception in either the preamble to the original rule or the preamble the recent MLA Rule. Instead, the Department makes a few references to “non-purchase money installment loans” in its discussion of the anticipated costs of complying with the 36 percent Military Annual Percentage Rate cap on loans made to covered borrowers. See, e.g., 80 Fed. Reg. 43560, 43602 (July 22, 2015). In the preamble to the original rule, the Department appears to focus its discussion on why vehicle title loans should be included on the definition of “consumer credit” without providing any clarity on the scope of the exception in then paragraph (b)(2)(ii).
The plain meaning of the rule, however, suggests that refinance transactions are not within the scope of the exception in paragraph (f)(2)(ii). The MLA Rule provides an exception for transactions “expressly intended to finance the purchase” of personal property or a motor vehicle “when the credit is secured by” the property or vehicle being purchased. The dictionary defines “purchase” to mean “to acquire by the payment of money or its equivalent; buy.” The plain meaning of the regulation, therefore, appears to only cover transactions where the covered borrower is buying a motor vehicle or personal property. Since, in a refinance transaction, a covered borrower does not typically buy a car or stove from himself but merely rolls over existing debt, it would be a stretch to try to fit that type of transaction within the plain meaning of the rule.
Furthermore, the MLA Rule expressly prohibits most refinance transactions unless the creditor is a bank, savings association or credit union. See, 32 C.F.R. § 232.8(a). To create an exception from the definition of “consumer credit” for refinance transactions in paragraph (f)(2)(ii) of Section 232.3, while also creating a prohibition of most refinance transactions in Section 232.8 would appear to create an inconsistency in the MLA Rule. Rather than inferring that the rule is logically inconsistent, a more likely reading of these two sections is that paragraph (f)(2)(ii) does not create an exception for refinance transactions. This preserves the general prohibition in Section 232.8 and avoids reading an ambiguity into the MLA Rule.
As for the argument that refinance transactions constitute “purchase money security interests” under state secured finance laws, courts appear split on this issue. Some federal appeals courts have held that refinancing a loan automatically extinguishes a “purchase money security interest.” Others have held that the “purchase money status” can survive and usually apply a dual status to different parts of the loan. See, e.g., In re Billings, 838 F.2d 405 (10th Cir. 1988) (providing a discussion of the apparent circuit split).
Given this ambiguity, it is unlikely that the DoD would adopt a definition of “consumer credit” or any exceptions that would invite uneven application of the protections of the MLA Rule. Furthermore, the dual-status approach that some courts have adopted could create compliance problems for credit unions since the Federal Trade Commission’s Credit Practices Rule (which I blogged on in April) prohibits creditors from taking a nonpossessory, nonpurchase money security interest in household goods. See, 16 C.F.R. § 444.2(a)(4).
Coming Soon: MLA Compliance Guide – NAFCU’s Director of Regulatory Compliance, Brandy Bruyere, has worked over the past few weeks on a compliance guide for credit unions addressing many key areas of the DoD’s MLA Rule including credit cards, security interests and calculating the MAPR. As many of our members know, Brandy is NAFCU’s resident expert on the MLA Rule. This guide is offered as a complimentary service to our members and will be available on NAFCU's website on May 5th. We have created an MLA landing page with access to all of the resources NAFCU offers on MLA Compliance available here.