If you are one of the
millions of Americans who borrows money, buys items on installment credit,
or cosigns for another person's debt, you may want to know about the
Federal Trade Commission's Credit Practices Rule. The Rule, which became
effective March l, l985, prohibits many creditors from including certain
provisions in consumer credit contracts. It also requires creditors to
provide a written notice to consumers before they cosign obligations for
others about their potential liability if the other person fails to pay.
Finally, it prohibits one method of assessing late charges.
What contracts are covered?
The Rule applies to consumer credit contracts offered by finance
companies, retailers (such as auto dealers and furniture and department
stores), and credit unions for any personal purpose except to buy real
estate. It does not apply to banks or bank credit cards; to savings and
loan associations; or to some non-profit organizations. (However, similar
rules for banks -- under the Federal Reserve Board -- and for savings and
loans -- under the Office of Thrift Supervision -- went into effect
January 1, 1986.) The Rule does not apply to business credit.
What contract provisions are
The Rule prohibits creditors from including certain provisions in their
consumer credit contracts. Specifically, credit contracts no longer can
include provisions that:
* Require you to agree in advance, should
the creditor sue you for non-payment of a debt, to give up your right to
be notified of a court hearing to present your side of the case or to hire
an attorney to represent you. (These clauses were often called
"confessions of judgment" or "cognovits.")
* Require you to give
up your state-law protections that allow you to keep certain personal
belongings even if you do not pay your debt as agreed. (These clauses were
called "waivers of exemption.") State law generally allows you to keep
your home, clothing, dishes, and other belongings of a fixed minimum
value. However, when the debt incurred is to purchase an item and that
item is used as security for the debt, it is permissible under the Rule
for a creditor to repossess that item.
* Permit you to agree in
advance to wage deductions that would pay the creditor directly if you
default on the debt, unless you can cancel that permission at any time.
(These clauses were called "wage assignments.") However, a wage or payroll
deduction plan, through which you arrange to repay a loan, is a common
payment method and is permissible under the Rule.
* Require you to
use as collateral certain household and uniquely personal items that are
of significant value to you but are of little economic value to a
creditor. Such items include appliances, linens, china, crockery,
kitchenware, wedding rings, family photographs, personal papers, the
family Bible, and household pets. (These were called "household goods
security" clauses.) However, if you borrowed money to buy any of these
household or personal items, and use the items as collateral, the creditor
can repossess the purchased item if you do not repay the loan.
What notices must be given to
When you agree to be a cosigner for someone else's debt, you are
guaranteeing to pay if that person fails to pay the debt. The Rule
requires that you be given a notice that explains the responsibility you
are undertaking. Under the Rule, the cosigner notice must say:
You are being asked to guarantee this debt. Think
carefully before you do. If the borrower doesn't pay the debt, you will
have to. Be sure you can afford to pay if you have to, and that you want
to accept this responsibility.
You may have to
pay up to the full amount of the debt if the borrower does not pay. You
may also have to pay late fees or collection costs, which increase this
The creditor can collect this debt from
you without first trying to collect from the borrower.* The creditor can
use the same collection methods against you that can be used against the
borrower, such as suing you, garnishing your wages, etc. If this debt is
ever in default, that fact may become a part of your credit
This notice is not the contract that
makes you liable for the debt.
* Depending on your state,
this may not apply. If state law forbids a creditor from collecting from a
cosigner without first trying to collect from the primary debtor, this
sentence may be crossed out or omitted on your cosigner notice.
This notice is not required when you receive benefits from the
contract, such as when you buy goods, take out a loan, or open a joint
credit-card account with another person. In these cases, you would be a
co-buyer, co-borrower, or co-applicant (co-cardholder) rather than a
cosigner. Therefore, the creditor would not be required to provide the
How can late charges be
A creditor can charge a late fee if you do not make your loan payment
on time. However, it is illegal under the Rule for a creditor to charge
you late fees or payments simply because you have not yet paid a late fee
you owe. This practice is called "pyramiding late fees." Under the Rule,
this means that if you do not include the late fee you owe with your next
regular payment, it is illegal for a creditor to subtract the late fee
from your payment and then charge you a second late fee because the
current payment is insufficient. For example, your loan contract may state
that your monthly payments are $100 and that you will be assessed a $10
late fee if you pay after the grace period. If you make your $100 loan
payment after that time and you do not include the $10 late fee with your
next $100 payment, a creditor cannot first deduct the missing $10 late fee
from the $100 payment, claim you have now paid $90, and then charge you an
additional late fee. But, if you skip one month's payment entirely, the
creditor can charge late fees on all subsequent payments until you bring
your account up to date.