What are debt suspension contracts and debt cancellation contracts? Are they even legal?

debt suspension contractDebt Suspension Contracts (DSC) and Debt Cancellation Contracts (DCC) are banking products that substitute for credit insurance.

The Comptroller of the Currency, Administrator of National Banks (OCC) finalized it’s regulation, 12 CFR part 37 effective June 16, 2003. This regulation covers DCCs and DSAs issued by national banks. These are banking products, not insurance products thus federal law, not state law, governs them and state insurance regulators have no role in the regulation of these products.

Debt Cancellation Contracts
The regulation broadly defines debt cancellation contracts and debt suspension agreements. A debt cancellation contract is defined as a loan term or contractual arrangement modifying loan terms under which a bank agrees to cancel all or part of a customer’s obligation to repay an extension of credit upon the occurrence of a specified event.

The regulation does not otherwise define what is a “specified event.” Thus, a national bank is free to design its contracts to address not only traditional events such as death, disability or involuntary unemployment of a borrower, but also any event that may reasonably be expected to occur in the life of a borrower.

What are debt suspension contracts?Debt Suspension Agreements
A debt suspension agreement is defined as a loan term or contractual arrangement modifying loan terms under which a bank agrees to suspend all or part of a customer’s obligation to repay an extension of credit from that bank upon the occurrence of a specified event. This definition is intended to cover debt suspension agreements under which interest continues to accrue during the suspension period, as well as those under which the accrual of interest is suspended. It also provides that a debt suspension agreement does not include arrangements in which the borrower unilaterally decides to defer a payment or the bank unilaterally decides to allow a deferral of a payment, so-called “skip-a-payment” agreements.

National banks, federal thrifts, and federal credit unions are authorized to enter into DCCs;

National banks and federal credit unions are authorized to enter into DSAs; and

Depending upon the jurisdiction, some state chartered entities may also be authorized to enter into DCCs and DSAs.

Although debt cancellation contracts seem similar to credit insurance, there is no insurance company involved so the lender can keep the entire fee. The OCC and the National Credit Union Administration have determined that national banks, federal thrifts and federal credit unions can sell DCCs (and, in the case of national banks and federal credit unions, DSAs) without being subject to state insurance laws.

The DCC/DSA must be offered by the lender making the loan, not by an affiliate of the lender. A national bank cannot require the borrower to enter into a DCC or DSA in order to receive a loan, or in order to obtain better terms on a loan. For example, a bank may not give a better interest rate to a borrower who purchases a DCC. This is similar to the OCC regulation on credit insurance.

The OCC has elected not to impose price controls on the products, relying instead on an existing OCC regulation that allows national banks to set non-interest charges and fees competitively in accordance with safe and sound banking principles. Single fee contracts connected to residential mortgage loans are banned. If a single fee contract is offered in connection with other types of loans, a customer must be given a periodic fee option. No-refund contracts must be offered with an option to buy a refund feature. This refund requirement does not apply to open-end credit.

What disclosures are required?
Banks must tell customers that purchase is optional, must explain applicable fee options, (e.g., lump sum payments, refunds), and must disclose eligibility requirements, conditions and exclusions applicable to contracts.

How must the disclosures be given?
Regulation includes both short and long form disclosures. Short form disclosures may be used in telephone sales, take-ones and in advertisements. Long form disclosures must be used in person-to-person solicitations. Disclosures must be given before a sale is final, and a bank must obtain a customer?s acknowledgment of the receipt of the disclosures.

Must a customer affirmatively elect to purchase the product?
As a general rule, a customer must affirmatively elect, in writing, to purchase a DCC/DSA. Oral affirmations are acceptable in telephone sales.

Prohibited Practices
The regulation prohibits banks from extending credit or altering the terms of an extension of credit on the condition that a customer enters into a debt cancellation contract or debt suspension agreement. This anti-tying prohibition effectively requires that these contracts be optional features of a loan.

View the entire 12 CFR part 37.

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