creates no problem of figuring the details of the original contract and creates no problem of stating the rate used in those computations. Assertion V The disclosure of the annual rate of finance charge, as required by the bill, will not achieve the economic stabilization objective of the bill. Interest rates and finance charges on consumer credit are not flexible, nor are consumers sufficiently concerned about annual rates to increase their buying when rates are reduced in recession. Reply No evidence has been produced to show that consumer credit is a stabilizing force in the present state of consumer ignorance of the cost of credit. In a price regulated economic system, stability is not to be expected when one party to the transaction does not know the full price of the commodities and services he buys; nor the price of the credit component of the cost of his purchases; nor the comparative price he will pay for credit and the price he can get for lending his savings. The bill will give consumers more. adequate information about prices. The consumer must be told the cash price of the goods he contracts for, their time or credit price, and the price of credit as a percent per annum on the amount he contracts to use. The bill requires more information than is proposed by other supporters of full disclosure, by requiring all creditors to state both the total finance charge, and the price of credit-the annual rate on the average unpaid balance over the period for which a contract is being negotiated. The American Bankers Association proposes similar disclosures except that they propose a deceptive statement of the price of credit. They propose a rate statement in terms of dollars per $100 of the original credit. The bill requires the dollars per $100 to be related to the average amount the debtor contracts to use, disclosing a rate almost twice as high as the rate disclosed under the bankers' association proposal. The fact that the true rate is double the rate usually quoted will make it effective as a factor in economic stabilization. It will bring the consumer up short and make him take another look at the whole contract, and particularly when he is prosperous and working full time, consider whether or not he would be better off if he saved a little more, at interest, before purchasing or borrowing. When the price of credit is revealed and becomes a matter of common knowledge, discussion, and shopping, then it is likely to become more flexible. Rate reductions will be more probable in times when the demand for money and for commodities is slack. Consumers have been insensitive to changes in the price of credit because they have been uninformed about it. The price of credit has been inflexible because the user of it has not known what prices were. Consumer credit extended at known prices will become less a leading factor in the economic instability, and become a counter-business-cycle force. The reduction of costs of finance which will follow open competition on rates will make more of the consumers' income available for purchases of goods and services at retail levels. MEMORANDUM 1. Definition of "Incident to the Extension of credit." 2. Application to various credit transactions. S. 1740 would provide leadership for State legislation on consumer credit with respect to disclosure of the annual rate of charge, and with respect to the definition of the total finance charge to be disclosed. The total finance charge is defined in the bill in the language that has governed Federal credit unions for 27 years. Small loan companies in States that follow the Uniform Small Loan Act have been governed by essentially the same rules. The bill requires: (1) Disclosure of the total finance charges in dollars which include any charges however labeled if they are incident to the extension of credit. (2) The statement of the total finance charge in terms of a simple annual rate on the outstanding, unpaid, or declining balance. Rules for application of this principle have been developed by State courts. The essential criterion is whether the borrower is required to pay the charge as a condition of obtaining the credit. Subordinate criteria also have been developed by courts. They could be used by the Federal supervisory agency as guides in writing regulations for the bill. The criteria should include the following: 1. Is the expense one which the debtor would not normally incur if he did not receive the particular extension of credit-if, for example, he purchased for cash? 2. Is it required by the creditor as a condition to extending credit? 8. Does it run for the same term as the credit? 4. Is the benefit of the charge primarily to the creditor and only secondarily to the debtor, or is the benefit of the charge primarily to the debtor and secondarily to the creditor? 5. Is the charge paid to the creditor or to a third party to purchase a service or protection for the debtor? Illustrations of the possible application of these criteria to several ordinary consumer credit transactions follow: EXAMPLE I Fotension of credit on new automobile: 36 months 1. Cash delivered price of automobile and accessories.... 2. Downpayment, or trade-in allowance.... 8. Difference between (1) and (2) to be paid in 86 equal monthly payments--------- 4. Itemized charges to be paid by debtor-not incident to extending credit: (a) Standard auto insurance-1 year--- (b) State sales tax............ 2,250 $185.00 90.00 (c) State license fee and tags...-- 28.00 (d) Title certificate____. (a) Direct finance charge at $6 per $100 per year on (b) Credit life insurance-on monthly unpaid balances.... (d) Investigation fee------ (e) Recording chattel mortgage-------. (f) Total finance charge----- $450.00 80.00 4.50 ------ 14.00 1.50 500 18 7. Simple annual rate (percent). In this example the foregoing criteria indicate that standard auto insurance is not incident to the extension of credit. It is an expense normally incurred by the debtor whether he borrows or not. Compulsory insurance and financial responsibility laws, as well as customs, bear this out. Although it is required by the creditor, the benefit is primarily to the debtor and to the public at large. The insurance is not terminated by prepayment of the loan. The charge is paid to an insurance company or agent to purchase protection for the debtor. Other charges which the debtor must pay whether he borrows or not, which include benefits primarily for the debtor, and which are required by State law. are State sales taxes, license fees and tags, and title certificates. Credit life, accident, and health insurance are expenses which would not normally have been incurred if the debtor did not obtain credit; are usually required by the creditor; cover only the unpaid balance and terminate when the loan is paid. They are, however, primarily for the benefit of the creditor, particularly when the creditor is the beneficiary designated in the contract, they reduce the risk the lender incurs and thus ought to result in a lower interest rate charged. They are incident to the extension of credit. Other charges incident to extending the credit are the investigation fees for eredit and appraisal of the property, and recording fee for the chattel mortgage. The first two are for the benefit of the creditor in evaluating the credit risk, the third is an expense which the debtor would not incur if he did not obtain credit. EXAMPLE II A consumer decides to borrow money from a financial institution whose business is to lend money. The borrower receives the full amount of the loan in cash, which he then is able to use in any way he desires. In this example the lender is extending credit without the pledge of security, to be repaid in 10 monthly installments. (1) Amount of cash borrowed___. $400.00 (Since this is not an installment sale of goods, items (2), (3), and (4) of sec. 4 do not apply.) (5) The amount to be financed is the same as (1). 400.00 (6) Finance charges incident to extending credit: (a) Direct charge: $6 per $100 per year on the origi- (b) Credit investigation fee.. $20.00 3.75 (c) Credit life insurance__ Total finance charge.. (7) Simple annual rate (percent). EXAMPLE III. RETAIL CREDIT TRANSACTION 14 A credit agreement is signed with a merchant for the purchase of a refrigerator. The purchaser agrees to repay monthly, according to a schedule, onetenth or the purchase price plus a service charge of 12 percent of the credit outstanding at the end of the previous month: 1. Cash and delivered price of goods purchased.. 2. No downpayment_--- 3. Difference between 1 and 2....... 4. No charges not incident to extending credit. 5. Total to be financed-- 6. Finance charges in dollars and cents-1% percent per month on unpaid balance___. 7. Simple annual rate (percent) - $200.00 0 200.00 200.00 16.50 18 In this example no charges other than the contractual monthly rate on the balance were added. The simple annual rate can be computed by multiplying the monthly rate by 12. The total dollar cost can be computed from tables based on constantly declining balances. If the debtor were required to pay in addition to the 1%1⁄2 percent per month service charge, the cost of credit life insurance, the simple rate would be higher, but could be readily computed. EXAMPLE IV. RETAIL REVOLVING CREDIT PLANS In the case of the various types of revolving or add-on credit plans which involve a series of small purchases and the credit plan does not involve any fixed repayment schedule, it appears that the supervisory agency would have to spell out separate rules governing disclosure as required by S. 1740 of these types of transactions. In order to avoid any burden for small merchants who extend these types of installment credit plans to their customers the following types of disclosure might be considered adequate to meet the intent of the bill. 1. Disclosure of annual rate.—The annual rate at which credit charges will be assessed against the purchaser's account could be correctly disclosed on the original credit agreement and on the monthly statements sent to customers. For instance, retailers assessing charges at a rate of 11⁄2 percent on the monthly unpaid balance, under the rules specified above, would also be required to disclose that this monthly percent rate is equivalent to an annual rate of 18 percent on the monthly unpaid balance. 2. Disclosure of total dollar costs.-The present custom is for retailers to clearly disclose in writing the monthly charges on revolving credit plans on monthly statements sent to customers. This existing dollar disclosure might be considered adequate for the purpose of S. 1740 if retail merchants also were required to total up these monthly charges for a previous 12-month period and thus disclose to the customer on an annual basis the total dollar cost incurred on the revolving credit plan during the preceding year. If this interpretation of the disclosure requirements of S. 1740 were regarded as sufficient to meet the purposes of the act, it would appear that the intent of the bill could be met without any burden for small retail merchants who sell on the installment plan. EXCERPT FROM HOUSING HEARINGS OF 1961 Pages 255-257 Senator DOUGLAS. Have you figured out, say on a $10,000 house, what the total interest charges will be for 40 years? Dr. WEAVER. Yes, I have. They are quite sizable-over double the amount of the house. Senator DOUGLAS. I notice Mr. Hardy has a book of figures before him. I wonder if we could get the exact figures of the total interest charges on a $10,000 house over a 40-year period. Dr. WEAVER. I think I can tell you off the top of my head this runs about $23,000 in interest. Senator DOUGLAS. $23,000 in interest? Dr. Weaver, we introduced a bill which I called the truth in interest bill, which required that on loans on purchases on the installment plan, the buyer or borrower should be told two things: first, what the total amount of the interest charges would be; second, what the annual rate upon outstanding balance would be. I want to congratulate FHA and the housing industry for observing very scrupulously the second provision. Interest is reckoned as an annual rate upon the outstanding balance. Would you favor a provision that in these cases the buyer upon the installment plan should be told what the total amount of the interest charges would be? Dr. WEAVER. Very definitely. Senator DOUGLAS. You would? Dr. WEAVER. I think it would be very unfair to do it otherwise. Senator DOUGLAS. Is that provided in your bill? Dr. WEAVER. I do not think it is, but we have no objection to it. Senator DOUGLAS. I congratulate you. This means that people who purchase houses under a mortgage will know what they are getting in for, will do it with their eyes open. I hope your example will spread, Dr. Weaver. Dr. WEAVER. Thank you. Senator DOUGLAS. That is all. Senator SPARKMAN. I am a little disturbed about that figure you gave of $23.000. What is the rate of interest? Dr. WEAVER. Five and a half or- Senator SPARKMAN. I was figuring in my head 5-percent interest over a period of 40 years on a $10,000 mortgage would be $10,000. I am just figuring 5 percent. Dr. WEAVER. No, I think Senator SPARK MAN. If there is orderly reduction, it will be. Dr. WEAVER. Apparently off the top of my head wasn't a good place to start from. Apparently the book is much better. We have now had it calculated, sir, and we find that it is $14,728 for 40 years at 5.5 percent. Senator SPARKMAN. That is better. I felt the record ought to be corrected. because I knew that figure could not be right. Senator DOUGLAS. What are the rates on these, 3% ? Dr. WEAVER. No, sir; this is 52. Senator DOUGLAS. But you would be ready to have that stated? Dr. WEAVER. Oh, yes, sir; definitely. If it had been $23,000, I would have been willing to have had it stated. Happy to have this figure. Senator DOUGLAS. Do you think that it should be stated on other FHA loans? Dr. WEAVER. I would be in favor of it, but I think particularly it is necessary here, because of two circumstances: first, because it is such a sizable amount, and, second, because many of the people involved will not have any way of finding out unless they are told. Senator WILLIAMS. May I ask a question? Senator SPARKMAN. Surely. Senator WILLIAMS. Dr. Weaver, is not the average homeowner's concern the monthly payment, the principal and interest, the amortization each month? It is not the total 40-year interest bill, it is what he pays each month, and he compares that with what he would pay in rent if he were not buying his house. Is not that the point? Dr. WEAVER. Absolutely: but I think, however, that the indication of what the total amount is is something that is desirable per se. I do not think it will deter many people, however. Senator WILLIAMS. It would be sobering but would not stop the program because of that psychology of, "What do I pay every month for rent and not what do I pay for the house?" Dr. WEAVER. I think the average person looks at what he pays for all of his fixed obligations and then he looks at what he can spend. Senator DOUGLAS. Dr. Weaver, would you be willing to extend the same principle to the 25-year modernization loans? That the borrower should know there what the total amount of interest will be? Dr. WEAVER. Definitely. Same principle, in my opinion. Pages 939-940 Senator DOUGLAS. Dr. Weaver, I want to commend you for the very fine forward step you have taken as regards the true interest rates on new homeimprovement loans under your proposal, on which, as I understand it, you stated the true rate of interest should not exceed 6 percent. You also stated that it was your plan that the total amount of the interest charge would also be stated? Dr. WEAVER. Yes. Senator DOUGLAS. Ought to be stated? Dr. WEAVER. Yes. Senator DOUGLAS. And you can do that by administrative order? Do you need legislation to do that? Dr. WEAVER. I do not think so. Mr. HARDY. As a matter of fact, sir, following the last session we had with the committee and with HHFA, we have gotten up a dummy pamphlet clearly setting forth what the interest charges would be on loans with maturities which we would propose to allow to purchasers of homes. We also have for some time give to each purchaser of an FHA home an amortization schedule keyed to his particular loan which clearly indicates the amount he pays each month to principal and to interest with the total interest shown. Senator DOUGLAS. This is very much of a forward step. And I want to both praise and congratulate the new administration for this effort. I think it is some progress in the effort to get the truth in lending. The question I want to ask now deals with the title I loans. I have here this digest of insurable loans issued by FHA, and there is an analysis of title I loans. These loans are made for alterations, repairs, and improvements, upon or in connection with existing structures. I understand that the interest rate is quoted at 5 percent upon these loans, but I find in the next-to-the-last column a statement that there is a $5 discount per $100 of the base amount a year on the first $2,500 and a 4-percent discount on amounts in excess of $2,500. When you take the discount into account, what will be the true interest rate on these title I loans? Dr. WEAVER. Mr. Hardy? Mr. HARDY. Approximately 9.4 percent. On a 3-year note the rate is 9.3 percent and on a 5-year note 9.05 percent. Senator DOUGLAS. 9.4 percent? Mr. HARDY. Yes. Senator DOUGLAS. I want to make two comments if I may. First, you are putting forward a new and liberalized program-and it is liberalized-and both the ostensible and real interest rate is 6 percent? Dr. WEAVER. Yes, sir. |