Charged Off Loans and Interest
The compliance team has heard from several members lately about the rules regarding charged off loans and interest. The questions focus on whether credit unions are permitted to continue charging interest after a loan had been charged off. There are a few different ways to look at this issue, which are covered below.
Regulation Z: The Periodic Statement Angle
Regulation Z does not provide a prohibition against charging interest after a loan has been charged off, but it does provide an exception to the periodic statement requirements for credit unions who do this. Periodic statements are required under section 1026.5(b)(2) for all open-end credit products and section 1026.41 for closed-end loans secured by a dwelling. Regulation Z does not require periodic statements for other types of closed-end loans, so these are not addressed.
Both rules provide an exception to the requirements for charged off loans if certain conditions are met. For open-end credit products, the conditions are:
- The loan has been charged-off according to loan-loss provisions and
- No additional interest or fees will be charged on the loan.
For closed-end loans secured by a dwelling, the conditions are:
- The loan has been charged-off according to loan-loss provisions,
- No additional interest or fees will be charged on the loan, and
- The credit union provides the "Suspension of Statements & Notice of Charge Off" disclosure within 30 days of the charge-off or most recent periodic statement.
As you can see, ceasing to charge interest on the loan is a condition for the exception in both cases. As a result, some credit unions have a policy to not charge interest once a loan had been charged off in order to take advantage of this exception in Regulation Z. However, it is up to each credit union to decide whether to do so. If a credit union wants to continue charging interest, the rules require it to continue sending periodic statements.
Nonaccrual Status: The Accounting Angle
NCUA rules generally prohibit credit unions from accruing interest after a loan is 90 days past due. This prohibition is stated in section 741.3(b)(2) and further explained in Appendix B to Part 741: “Credit unions may not accrue interest on any loan upon which principal or interest has been in default for a period of 90 days or more, unless the loan is both ‘well secured’ and ‘in the process of collection.’”
When this happens, it is referred to as nonaccrual status and is an accounting requirement. While not all loans in nonaccrual status are going to be charged-off loans, this requirement does generate some confusion as to a credit union’s ability to charge or collect interest after a loan has been charged off. However, Appendix B does remind credit unions “[p]lacing a loan in nonaccrual status does not change the loan agreement or the obligations between the borrower and the credit union.” Which brings us to the third angle on this issue.
Loan Agreements: The Contract Angle
Although a credit union might be obligated to stop accruing interest on the accounting side, that does not necessarily impact a credit union’s rights to enforce what the member owes under the contract. In other words, charging off a loan does not impact a credit union’s ability to collect what is owed under the contract, including interest. Careful review of the contract may be appropriate in these cases to determine how interest is treated after a loan is charged off.
Ultimately, credit unions might want to work closely with their accountants and attorneys in assessing whether to continue charging interest and the implications of doing so. Keep in mind that decisions regarding whether to charge interest could come from internal policies or contractual language rather than a regulatory prohibition. However a credit union decides to proceed, it may want to ensure its loan policies reflect its practices.