Alert

Possible Issue of Concern for Lenders Making Unsecured Loans

Summer 2009

McGlinchey Consumer Finance Alert

In 2008, Congress passed, and President Bush signed, the Higher Education Opportunity Act (“HEOA”), the most important pieces of legislation relating to higher education and education finance in several years.  In addition to many provisions relating to government loans, the HEOA contains new restrictions on the marketing of both government loans and private education loans that are designed to eliminate conflicts-of-interest for schools in their position between borrowers and lenders.  Finally, the HEOA revised the Truth in Lending Act (“TILA”) to create a series of new provisions that apply only to private education loans.  While a few of the new TILA provisions impose substantive limitations on the terms of private education loans, most of the revisions to TILA require lenders to provide several new disclosures to potential student loan borrowers.  

The HEOA directed the Federal Reserve Board to revise both Regulation Z and the Regulation Z Commentary to implement the new provisions of TILA that regulate private student loans.  The FRB published proposed regulations and additional commentary (the “Proposal”) in March, 2009.  Lenders who do not have a student loan department or who do not make loans clearly intended to fund educational expenses may believe that the Proposal does not concern them.  Such lenders should note, however, that the Proposal  raises an issue for any lender who makes closed-end consumer loans secured by collateral other than real property.

The Proposal’s definition of a “private education loan” includes a loan that is “extended expressly, in whole or in part, for postsecondary educational expenses to a consumer.”  Thus, as proposed, the new disclosures and all other rules applicable to private education loans would apply to an entire loan, any part of which has been identified as intended for postsecondary educational expenses.  A lender who makes a loan for several purposes, one of which is for financing education expenses, would therefore need to comply with the new rules.

The comment period for the Proposal closed on May 26, 2009.  Discussions among the private loan industry led to several comments being filed that urged the Board to reconsider this definition. The commenters were concerned that the proposed definition was so broad that many lenders who are not in the business of private education lending would inadvertently fall within the scope of the Proposal. If a loan applicant were to indicate that any portion of a loan may be used to help finance postsecondary education expenses, the lender would be subject to the special rules for private education loans in the Proposal. It is highly unlikely that a lender who is not in the business of student lending will be in a position to comply with the new rules. Thus, the Proposal would create compliance problems and the potential for liability for lenders under TILA.  

The commenters have pointed out that Title X of the HEOA defines “private education loan” as a loan issued “expressly” for qualified higher education expenses.  The commenters believe that, on the basis of that statutory definition, the Board erred by including multipurpose loans within the scope of the Proposal. The commenters have requested that the phrase, “in whole or in part” be removed from the regulatory definition so only those loans expressly marketed for use in paying higher education expenses would be subject to the new disclosure requirements.

Final rules are expected in mid-August, 2009.  The education finance industry is hopeful that the Board will narrow the scope of the new private student loan rules as the comments suggested, but the Board’s final decision on this issue will not be known until it publishes its final rules. All consumer lenders should be aware of this issue and look for its resolution later this summer.