Lending compliance: two words that, together, conjure up endless stacks of regulations and a maze of calculations. Yet, for lenders, they represent something more vital—protections for both business and borrower.
Navigating the ins and outs of compliance is a journey through the details of APR, the Truth in Lending Act (TILA), state-by-state laws, and complex interest rate structures. It’s easy for lenders to trip up, and the consequences are no small matter. Here’s what you need to know to stay on the right side of compliance.
APR: More Than Just a Number
The Annual Percentage Rate (APR) sounds straightforward enough, but ask any lender, and they’ll tell you it’s anything but. The APR isn’t simply an interest rate; it’s the interest rate plus additional costs of credit, like certain fees. But here’s where it gets tricky: each state has different rules about what’s considered a finance charge. For example, credit insurance might be optional in one state and mandatory in another, impacting the “all-in” APR that consumers see.
There’s also a difference between APR and the interest rate on a contract. Simple interest is calculated daily on the remaining loan balance, but an APR incorporates extra fees to reflect the loan’s real cost over a year. Add-on interest and discount interest rates can further complicate the calculations, making it crucial for lenders to nail these differences.
Missing the mark isn’t just a technical error—it can lead to consumer confusion, legal action, and serious regulatory consequences.
The Truth in Lending Act (TILA): More Than Disclosure
Signed into law over five decades ago, TILA was one of the first consumer protections for lending, and it has evolved to ensure consumers understand the cost of credit. But the “Fed Box”—the section of disclosures that lists the loan’s APR, finance charge, and other essentials—is where the rubber meets the road. These elements must be in a standardized format, making it easier for consumers to compare offers from different lenders.
TILA’s most critical aspect is clarity. For example, the APR must be bold and prominent, while other information should follow clear guidelines. A slip-up here might seem minor, but for regulators, it signals that a lender may need to provide full transparency. The result? Potential fines and the risk of losing consumer trust.
Why Compliance is Different Across State Lines
The rules of compliance change with each border you cross. Operating in multiple states means lenders need to navigate a web of state-specific regulations. Take New York, for example. The state’s consumer lending laws are as complex as they come, and you won’t find everything you
need in the standard codebook. To discover New York’s maximum usury rate, lenders need to dig into the penal code—a twist that can surprise even the most prepared lender.
In contrast, California recently tightened its scrutiny on interest rate “exportation,” a practice where lenders use a federal charter to bypass state-imposed rate caps. Lenders assuming a blanket approval to use exportation rates may be in for a rude awakening as state regulators continue to chip away at this approach.
The Federal Calendar: Small Detail, Big Impact
Believe it or not, the federal calendar—often called the “actuarial method”—is crucial in calculating APR. Unlike daily interest that accrues each day, this periodic method standardizes loan payments over set periods. The twist? This calendar doesn’t recognize leap years. Lenders need to decide: do they ignore the extra day in February every four years or count it? Different systems make different choices, and lenders who aren’t careful may find themselves with discrepancies that require an entire recalibration. These “small” details can be costly, making it critical for lenders to verify their math aligns with compliance standards.
Choosing the Right Tools: APR Calculators Are Not One-Size-Fits-All
If you’ve searched for an APR calculator online, you know the options are plentiful. However, using a general calculator can be a risky shortcut. Many APR tools provide only an approximate calculation based on simple assumptions, ignoring the nitty-gritty details like state-specific requirements or non-standard charges. When auditors come knocking, “close enough” won’t cut it.
A reliable compliance partner will consider everything from state usury laws to the intricacies of compound interest calculations, ensuring your APR is legally sound. This is especially valuable when compliance mistakes could lead to regulatory scrutiny or legal issues.
Generative AI in Compliance? Proceed with Caution
As AI and generative technology advance, some lenders are eyeing tools like ChatGPT for compliance support. While the potential is huge, it’s essential to proceed with caution. Recent cases have shown that generative AI can “hallucinate” information, confidently providing incorrect citations or creating imaginary facts. A misstep in a compliance scenario could mean the difference between adhering to a state law and unknowingly violating it.
One cautious approach is using generative AI for internal knowledge checks, with strict verification procedures. Some companies have started testing tools to sift through their own documentation but have stopped short of using AI for consumer-facing calculations.
Compliance is a Marathon, Not a Sprint
The lending world is complex, and the path to compliance is an ongoing journey. With constant regulatory updates and state-specific laws to consider, lenders must prioritize a proactive approach to compliance. From TILA’s standardized APR disclosures to the complexities of multi-state lending, the stakes are too high for shortcuts. Staying compliant in the lending industry means more than following rules—it’s about building trust and ensuring clarity for every customer.
For more insights on lending compliance, APR pitfalls, and TILA requirements, check out our latest episode of The Lending Link Podcast, featuring Sarah Way Milovich, General Counsel and VP of Compliance at Carleton, Inc.
