In the labyrinthian darkness that is Regulation E lurks a potential trap of which not all adventurers are aware. One of the potential deadfalls in the regulation is the prohibition of requiring automatic debits for loans. This seemingly common forbidden practice is buried pretty deep in the text.
- 1005.10(e) Compulsory use— (1) Credit. No financial institution or other person may condition an extension of credit to a consumer on the consumer’s repayment by preauthorized electronic fund transfers, except for credit extended under an overdraft credit plan or extended to maintain a specified minimum balance in the consumer’s account.
(2) Employment or government benefit. No financial institution or other person may require a consumer to establish an account for receipt of electronic fund transfers with a particular institution as a condition of employment or receipt of a government benefit.
When we turn this into plain language, it is stating that a bank cannot base the approval of a loan on a customer agreeing to use automatic debits for making payments on the loan.
The background to this prohibition is to protect consumers from stacking up fees from multiple sources due to one transaction. If a loan payment is debited from a checking account and there are insufficient funds to cover the payment, the customer will get a late fee from the loan and an NSF fee from the deposit account. This regulation will, at a minimum, allow the customer to have made the choice for the automatic payment and not be forced into this situation.
The commentary to this provision does, however, offer some guidance and potential relief for banks. A bank can incentivize a customer to set up an automatic payment. A bank can offer, for example, a discounted APR or a reduced origination fee for the customer setting up automatic payments. This may be both a benefit to the customer and the bank.
If you read the entire regulatory citation above, you noticed a seemingly oddly placed additional prohibition. A bank cannot dictate where an employee receives their direct deposit. A bank can require direct deposit, however the employee gets to choose where the deposit goes.
Be sure to review your loan policies and educate your lending staff about this prohibition. The penalties can be steep—up to $1,000 per individual and up to $500,000 for a class action, plus actual damages. So, as you navigate the labyrinth be sure to avoid its many dead-ends and traps … the Minotaur is in there.