In December 2018, the Department of Defense dropped a bombshell (not literally) on the auto finance industry by issuing a new interpretation of the Military Lending Act.
The new interpretation imposes a range of restrictions and requirements on creditors who provide credit-related products and services—such as cash-out financings and financing for Guaranteed Auto Protection, credit life, and credit disability—to active-duty members of the US armed forces and those members’ dependents.
The kicker? The rule extends to transactions dating back to October 3rd, 2016.
To keep you up to speed, here’s some background of the Military Lending Act (or, MLA for short), what this new interpretation means, and how members of the industry can comply with the DoD’s latest requirements.
We asked Eric Johnson, partner at the law firm Hudson Cook to give us some background. (Before we dive in, please keep in mind that this article does not provide legal advice, and heed Eric’s recommendation that companies talk about these issues with their attorneys.)
What Is the Military Lending Act?
The Military Lending Act was enacted by Congress in 2006, and implemented by the Department of Defense (or DoD for short) in 2007. In simple terms, the law provides consumer finance protections to servicemembers and their dependents. Initially, the Military Lending Act covered three narrow categories of “consumer credit.”
There are certain important exclusions from the definition of “consumer credit,” as applicable to vehicle dealers: the law covers any credit transaction “expressly intended to finance the purchase of a motor vehicle, when that credit is secured by the vehicle,” or “any credit transaction to finance the purchase of personal property.”
The Military Lending Act requires that a creditor may not impose on a covered borrower a “military annual percentage rate” that’s greater than 36%. Keep in mind that the law’s definition of an MAPR is significantly broader than the definition of a traditional APR: an MAPR “includes all cost elements associated with the extension of credit, including fees, service charges, renewal charges, credit insurance premiums, any ancillary products sold, and any other charge or premium with respect to any extension of credit to a servicemember of the servicemember’s dependent.”
The creditor must also provide certain mandatory written disclosures, in a similar fashion to the disclosures creditors provide under Regulation Z of the Truth in Lending Act, but there’s also a requirement to provide certain oral disclosures, including a statement of the MAPR, TILA disclosures, and a clear description of payment obligations. Creditors may give these disclosures in person or over a toll-free number. For transactions covered by the Military Lending Act, Creditors are also prohibited from using other, onerous legal provisions or relying on arbitration agreements (i.e. no class action waivers), in the event of a dispute with the consumer.
Prior Changes to and Interpretations of the Military Lending Act
In 2013, the law changed to require the DoD to consult with other federal agencies, such as the Consumer Financial Protection Bureau or Federal Trade Commission, on potential revisions to MLA regulations.
Then, in 2015, the MLA changed once again, extended protections to a broader range of closed-end and open-end credit products (generally, those covered by the Truth in Lending Act), along with a few other changes. The good news was, at that time, that the MLA retained exclusions for…
- any credit transaction that is expressly intended to finance the purchase of a motor vehicle when the credit is secured by the vehicle being purchased; and
- any credit transaction that is expressly intended to finance the purchase of personal property when the credit is secured by the property being purchased.
The changes took effect on—you guessed it—October 3rd, 2016. Can you tell where this is going? Keep reading…
In addition to these changes, there have been 2 interpretations of the MLA regulations. The first was in August of 2016, when the DoD issued an interpretative rule styled as a Q&A series, with 19 different questions and answers that addressed a wide variety of questions raised by industry and trade groups. The DoD clarified that this interpretative rule did not change the regulation, but was more of a statement of the department’s preexisting interpretation.
Nonetheless, one Q&A provided in the interpretation raised uncertainty for auto lenders:
“Does credit that a creditor extends for the purpose of purchasing personal property, which secures the credit, fall within that exemption for ‘consumer credit’ if the creditor simultaneously extends credit in an amount that is greater than the purchase price?”
The DoD’s answer contended that if lenders finance items that are beyond the personal property being financed, then that takes the transaction outside the scope of the personal property exception in the MLA. In other words, that transaction must then comply with the terms of the MLA and the associated written and oral disclosures, arbitration prohibition, restrictions, and so on.
This answer caused readers to wonder: Did the DoD take a similar narrow view of the motor vehicle financing exclusion?
And so, last December, the DoD responded to requests for clarification and issued a second interpretation of the MLA regs, which brings us to…
The Second Interpretative Rule (i.e. Why We’re Here)
In the DoD’s second interpretation, the Department amended 3 prior Q&As, and added a new one. Again, the Department asserted that this interpretive rule doesn’t change the regulation, but merely states their preexisting interpretation.
However, this interpretation applies to the regulations that were issued back in 2015, and which were effective October 3rd, 2016. In other words, while the DoD may not consider this rule a change to the regulation, it significantly changes many auto lenders’ understanding of their obligations under the law.
Here’s what the DoD wrote (emphasis added):
- Does credit that a creditor extends for the purpose of purchasing a motor vehicle or personal property, which secures the credit, fall within the exception to “consumer credit” under 32 CFR 232.3(f)(2)(ii) or (iii) where the creditor simultaneously extends credit in an amount greater than the purchase price of the motor vehicle or personal property?
Answer: The answer will depend on what the credit beyond the purchase price of the motor vehicle or personal property is used to finance. Generally, financing costs related to the object securing the credit will not disqualify the transaction from the exceptions, but financing credit-related costs will disqualify the transaction from the exceptions.
…
A credit transaction that finances the object itself, as well as any costs expressly related to that object, is covered by the exceptions in § 232.3(f)(2)(ii) and (iii), provided it does not also finance any credit-related product or service. For example, a credit transaction that finances the purchase of a motor vehicle (and is secured by that vehicle), and also finances optional leather seats within that vehicle and an extended warranty for service of that vehicle is eligible for the exception under § 232.3(f)(2)(ii). Moreover, if a covered borrower trades in a motor vehicle with negative equity as part of the purchase of another motor vehicle, and the credit transaction to purchase the second vehicle includes financing to repay the credit on the trade-in vehicle, the entire credit transaction is eligible for the exception under § 232.3(f)(2)(ii) because the trade-in of the first motor vehicle is expressly related to the purchase of the second motor vehicle.
…
In contrast, a credit transaction that also finances a credit-related product or service rather than a product or service expressly related to the motor vehicle or personal property is not eligible for the exceptions under § 232.3(f)(2)(ii) and (iii). For example, a credit transaction that includes financing for Guaranteed Auto Protection insurance or a credit insurance premium would not qualify for the exception under § 232.3(f)(2)(ii) or (iii). Similarly, a hybrid purchase money and cash advance credit transaction is not expressly intended to finance the purchase of a motor vehicle or personal property because the credit transaction provides additional financing that is unrelated to the purchase. Therefore, any credit transaction that provides purchase money secured financing of a motor vehicle or personal property along with additional “cashout” financing is not eligible for the exceptions under § 232.3(f)(2)(ii) and (iii) and must comply with the provisions set forth in the MLA regulation.
Essentially, the DoD is saying that “it depends.” A determination of whether credit extended beyond a motor vehicle’s purchase price falls into the exemption depends on what the credit beyond the purchase price is used to finance.
The Department’s answer divides transactions into two buckets. The first is costs that are related to the object securing the credit—in other words, costs related to the motor vehicle securing the credit. If it’s related to the object, then that exemption is otherwise intact. This would include, for instance, credit that finances the purchase of a motor vehicle, as well as optional leather seats, an extended warranty for service, or negative equity. Anything related to the object that’s being financed and securing the credit falls within the exemption.
If the costs are credit-related costs, however, there is no exemption—which means all of a sudden the lender needs to comply with the Military Lending Act. The examples the DoD provides in this section are where the issue lies: the Department gives an example of a credit transaction that includes financing for GAP or credit insurance premium, plus cash-out financings, explaining that those would blow the exemption, and that a lender would therefore have to comply with the Military Lending Act.
This rule would have already given lenders migraines if it applied to only future deals, but remember, this DoD interpretation covers all contracts that have been entered into after October 3rd, 2016.
And there are serious enforcement provisions and penalties of non-compliance. A knowing violation of the law is a misdemeanor that could lead to fines, prison time, or both. Any contract that’s in violation of the Military Lending Act is void from its inception. There’s civil liability in the form of actual and punitive damages, and attorney’s fees and costs. The arbitration agreement is unenforceable. And the law can be administratively enforced by, for example, the CFPB, the FTC, or other federal prudential regulators. Last but not least, the statute of limitations is quite long: 2 years from discovery, up to a max of 5 years.
Business Implications
Where are we now, and how does this affect dealers?
Let’s review: a credit transaction that finances the purchase of the collateral—and any cost expressly related to that collateral—is exempt. Remember the DoD’s examples: leather seats, extended warranty for service, and negative equity.
If, however it’s a credit transaction that finances the purchase and a credit-related product or service, then it’s not exempt. Again, remember the DoD’s examples of GAP and credit insurance.
As a result of the second interpretation, lenders are stuck in something of a quagmire, which is why lenders and dealers should talk to their counsel. Right now, it doesn’t appear that there is a remedy for deals that have already been closed past October 3rd, 2016. These deals may have been assigned to a bank or finance company, and they’re on the books.
Going forward, companies have several options, but none of them are completely ideal. Outside of hoping the issue will resolve itself, or discontinuing GAP and credit insurance products entirely, a company could end the sale of GAP and credit insurance products to active military members and their dependents. Many members of the industry have taken or are taking this approach.
While Eric took pains to cover the ins and outs of the MLA, and we’ve reiterated many of his points here, this is still just an overview. And we can’t stress this enough—talk to your lawyer.
