Consumer Credit

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CONSUMER CREDIT

Short-term loans made to enable people to purchase goods or services primarily for personal, family, or household purposes.

Consumer credit transactions can be classified into several different classes.

Installment credit involves credit that is repaid by the borrower in several periodic payments; loans repaid in one lump sum are classified as noninstallment credit. Installment credit has expanded in popularity, with an increasing number of consumers buying goods on credit in order to spread repayment of the purchase price and the interest owed on the principal borrowed over an extended time.

Originator and Holder

The originator of credit is the person or company who originally extended the credit, while the holder is the individual or business who obtained the debt at a discounted price in order to collect payments at a subsequent time. Auto dealers are credit originators at the time a consumer purchases an auto on credit, but many loans are subsequently assigned by them to banks or sales finance companies, which become credit holders.

Commercial banks buy many consumer installment loans from car dealers and department stores and also participate in all aspects of consumer credit transactions both as originators and holders. The portion of the consumer credit market attributable to banks has greatly increased due in large part to widespread use of bank credit cards.

In addition, two types of finance companies are active in the consumer credit industry. The first type is the small loan company, which has contact with consumers as originators and makes loans to them directly. The other type is the sales finance company, which does not deal directly with consumers; it purchases and holds consumer installment debts related to the sale of durable goods on time. The distinction between the two decreases in importance as consumer finance companies diversify and engage in business on both levels.

Vendor and Lender

The law might regard credit differently, depending on whether it is offered by a vendor (seller). When an appliance store gives credit to customers who buy such items as washing machines and refrigerators and pay for them over a certain period of time, this action is known as vendor credit. When a consumer borrows funds from a finance company to pay for appliances, this action is known as lender credit, since the finance company lends but does not sell.

Some states exempt vendor credit transactions from the provisions of state usury laws. A vendor or a lender can charge the consumer interest (a fee for the use over time of borrowed money). In the past, usury statutes restricting the legal interest rate have ordinarily been applied only to lender credit. The difference in the treatment of lender credit and vendor credit is based upon the assumption made by law that vendors are able to adjust their prices to allow for the period during which they await payment. If, for example, the vendor's time price was excessive in that it allowed for a high interest rate, then the consumer could opt for payment of the cash price. Courts believe that competitive pricing will prevent vendors from charging too much interest when they extend credit. It is the seller's right to determine how to reduce the time price to encourage consumers to pay cash for goods.

Some courts have found since 1970, however, that these principles have no application to revolving charge accounts because department stores do not charge consumers less for paying for items in cash. There is one uniform purchase price, regardless of whether the sale is a credit or cash transaction. Both finance charges and tax are computed on the basis of the cash price.

In cases where courts have indicated that state usury laws must necessarily be applied in the vendor credit extended through revolving charge account customers, state legislatures have enacted statutes to increase the legal rate of interest that may be charged on such accounts. Most consumer credit cannot exist within the usury law limits; therefore, the pattern has been to enact laws that permit special higher finance rates for vendor credit to consumers.

Licensing Creditors

Banks, savings and loan associations, and finance companies ordinarily must be licensed under state or federal statute. Credit companies that purchase retail installment debts from sellers are also subject to governmental licensing regulations.

When the licensing requirement is primarily a revenue-raising device, potential licensees often need only file the appropriate forms and pay the required fee to obtain a license. However, when the licensing provisions require the applicant to be reputable and reliable, the public is protected only if the licensing agency has the energy and resources to investigate the applicant's qualifications.

Credit Reports

When a consumer makes an application for credit, the creditor must decide whether he or she is a good risk. Most creditors regularly order a credit report on an applicant rather than undertake a costly investigation on their own. Files are retained by two types of credit agencies.

Credit Bureaus Credit bureaus publish reports which are primarily used by merchants who are attempting to decide whether to allow consumers to purchase merchandise financed by credit that will be repaid on time. Such reports ordinarily disclose financial information, such as the location and size of an individual's bank accounts, charge accounts, and other debts and the person's bill-paying habits, income, occupation, marital status, and lawsuits.

Credit bureaus supply such information to a group of subscribers who, in exchange, provide them with information for their files. All the information obtained is filed in case it is requested by someone in the future. Nonsubscribers can ordinarily obtain information through the payment of a fee.

A majority of credit bureaus are members of the Associated Credit Bureaus of America, which regulates public information for them. It keeps members apprised of financial transactions that might cause people to be unable to meet their obligations.

Credit Reporting Bureaus Credit reporting bureaus formulate financial reports on individuals for purposes not directly related to the extension of credit. Such reports are used by employers to evaluate job applicants, by insurance companies to assess the risk in relation to a prospective policy buyer, and by landlords to avoid renting to tenants likely to cause damage to the property or disturb other tenants. Bureaus of this type compile data and provide it upon request to interested parties.

These reports contain personal information about the subjects and their families that is obtained from interviews with neighbors, associates, and co-workers. Information is kept for possible future investigation requests.

Problems In the late 1960s, Congress investigated abuses in the collection and dissemination of information by credit bureaus and determined that such bureaus compiled files on more than 50 percent of the people in the United States. These information files, however, frequently contain inaccurate, misleading, or irrelevant facts and were not kept confidential. The most frequent error was to confuse two individuals having the same name or similar names. The possibility of committing this error increased as the area covered by the bureau became larger.

Supervision Many states have enacted statutes to regulate the business practices of credit bureaus. However, the need for national uniformity led to the enactment of federal laws dealing with consumer credit information.

The fair credit reporting act, which is title VI of the consumer credit protection act (15 U.S.C.A. § 1601 et seq.), was enacted in 1970. This congressional enactment affects and regulates businesses that regularly obtain consumer credit information for other businesses, either for payment or in a cooperative exchange.

The law covers any report by an agency if it is related to a consumer's creditworthiness, credit standing or capacity, character, general reputation, personal characteristics, or mode of living. Further, the law applies to any such report when employed or expected to be used for evaluating a consumer for one of four purposes: credit or insurance for personal, family, or household use; employment; licenses to operate particular businesses or practice a profession; and any other legitimate business need.

The requirements of the Fair Credit Reporting Act affect (1) the credit bureau; (2) the businesses that use the credit reports compiled by credit bureaus; (3) the rights of consumers who are the subjects of such reports; and (4) how the consumer can enforce his or her rights when errors are discovered in such reports.

Credit bureaus are required to have standard procedures for determining and updating the accuracy of the information in their files. There is a seven-year limit on the information on file, except where the file discloses that the party was bankrupt within a period of ten years. Data relating to an individual's character, reputation, or lifestyle that are obtained through personal interviews with neighbors and friends cannot remain in a file unless it is verified every three months.

While the Fair Credit Reporting Act does not prohibit the collection and compilation of information unrelated to finance—such as appearance, political tenets, and sexual orientation—such information must be accurate and not obsolete. The law does, however, restrict credit bureaus to furnishing reports for reasons of credit, insurance, employment, obtaining a government license or other benefit, or other legitimate business needs related to business transactions with the consumer. Credit bureaus are required to investigate new clients to ascertain that they are using reports solely for one of these five permitted purposes. In addition, prospective clients are required to file a statement with bureaus certifying the purpose for which the reports will be used and agreeing not to use them for any other purposes.

Consumers are legally entitled to ascertain that no inaccurate or obsolete information is kept in files on them and to be notified when a creditor relies upon a report issued by a credit bureau, so the consumer can see the type of information kept on file and correct all mistakes in it.

A consumer, however, has no right to examine the actual file kept on him or her by a credit reporting agency. Anyone who has been refused credit on the basis of a report can discover the nature and substance of all but medical information contained therein, as well as the source of the information, except investigations based on comment from neighbors and associates. The consumer can also find out the identity of anyone who has received the report for employment purposes during the last two years or any other purpose during the last six months.

A consumer who discovers inaccurate or misleading information in his or her file can request that the agency reinvestigate his or her credit background and submit a brief statement which either explains or corrects the information. The agency must include such information in the consumer's file and notify recent users of the changes in the consumer's file upon the consumer's request.

Federal agencies, such as the federal trade commission (FTC), can issue orders for the enforcement of this law. Officers and employees of the credit bureau who willfully or intentionally violate this law are subject to criminal prosecution. Both a fine and imprisonment for each violation can be imposed upon conviction.

A credit bureau that fails to treat a consumer in the manner required by this law can be sued by the consumer who must prove that the credit bureau or the business that used the report did not properly maintain reasonable procedures to ensure compliance with the law. The consumer must also show that such failure to maintain was negligent or careless and that he or she incurred personal or financial injury from this failure.

Credit Discrimination

Discriminatory practices in the granting of credit led to the enactment of legislation to ensure that all qualified applicants have the same opportunity to receive credit.

Sex In the past, women were systematically denied credit regardless of whether they would be able to repay their loans. It was not uncommon for bankers to refuse to consider a married woman's income when a couple applied for a loan or a mortgage. Banks made the assumption that a woman of childbearing age was an automatic credit risk.

Single women had greater difficulty than single men in obtaining credit, particularly home mortgages. Creditors were also reluctant to extend credit to married women in their own names and refused to count a woman's income when calculating the creditworthiness of a married couple. Women also had a difficult time reestablishing credit upon divorce or widowhood.

In 1974, Congress enacted the Federal Equal Credit Opportunity Act (15 U.S.C.A. § 1691 et seq.), which prohibits credit discrimination based not only upon sex and marital status, but also upon race, religion, and national origin. It has, however, very detailed prohibitions against discrimination based upon sex and marital status. Creditors are not permitted to (1) assign a value to sex or marital status in calculating an applicant's creditworthiness; (2) assign a value to having a telephone in the name of the applicant; (3) question a married couple's childbearing plan; (4) alter the terms of credit or require a reapplication when there is a change in an individual's marital status; (5) refuse to consider the total income of the couple who are making the application; (6) delay action on an application or refuse to consider it; or (7) discourage an individual from making an application for credit.

Federal agencies such as the FTC can guard against violations of this law through the issuance of restraining orders. In addition, consumers can commence an action against creditors who have denied them an equal opportunity to acquire credit. Where credit discrimination is prohibited by a state law also, the consumer can choose whether to pursue the state or the federal remedy.

Other Types of Discrimination Subsequent amendments to the Equal Credit Opportunity Act were concerned with race and age discrimination. The act provides that a creditor can take an applicant's age into consideration only in a situation where older people are given a preference or where a specific type of credit is allowed someone because that person is elderly. The law also requires that public assistance benefits be counted by creditors as a portion of an applicant's income. The race of an applicant cannot be used as a ground for the denial of credit.

Disclosure of Terms Until the late 1960s, there was considerable variety as to the information given consumers about their credit arrangements. The greatest lack of uniformity was in the statement of the rate of interest charged. Some creditors did not disclose the rate of interest, telling consumers only the number and amount of monthly payments. Those creditors that did state the rate of interest stated it in a variety of ways.

In response, Congress enacted the truth in lending act as Title I of the Consumer Credit Protection Act of 1968. The law is essentially a disclosure statute, offering little substantive protection to consumers. A creditor is free to impose any charges for credit permitted by state law. In addition, the statute does not restrict or confine the terms and conditions of the extension of credit. All that the Truth-in-Lending Act requires is that the consumer be informed of the terms and conditions of the credit transaction.

Under the statute and FTC regulations, the creditor must describe the credit terms clearly and conspicuously in a disclosure statement. At the time of disclosure, the creditor must furnish the customer with a copy of the statement. The disclosure requirements of the act are detailed and complex, because they deal with many types of credit transactions. In general, the creditor must disclose the amount financed, the annual percentage rate, and any finance charges associated with the extension of credit to the consumer. Any charges payable in the event of late payment must also be disclosed.