Terminating or freezing open-end credit
Do you have 99 problems and an open-end credit account is one of them? We have previously blogged about limitation of services, but what happens when you want to terminate or freeze open-end credit accounts? The first thing you should do is check the account agreement to see if the member has violated any terms of the agreement. Second, you should check to see whether Regulation Z prohibits freezing or terminating an account prior to maturity.
Regulation Z, section 1026.11(b), discusses account termination for open-end credit. This section focuses on termination due to inactivity. Specifically, section 1026.11(b)(1) prohibits a creditor from terminating an account prior to its maturity when the reason for the termination is solely because the consumer has not incurred a finance charge. However, section 1026.11(b)(2) provides an exception to this rule. Section 1026.11(b)(2) permits a credit to terminate an account if the account has been inactive for three months or more. Under section 1026.11(b)(2), an account is considered inactive if:
1. No credit has been extended to the consumer, such as;
a. By purchase;
b. Cash advance; or
c. Balance transfer; and
2. There is no outstanding balance on the account.
While Regulation Z does permit a credit union to terminate an account due to inactivity, credit unions may still want to review its loan agreements to ensure that early termination would be permitted under the contract.
Though section 1026.11 is applicable to all open-end credit, if a home-equity line of credit is involved, additional rules apply. Specifically, section 1026.40(f) places limitations on what a creditor may do, or not do, in regards to home equity plans. Section 1026.40(f)(2) generally prohibits a creditor from terminating a plan prior to the maturity date, except under the following circumstances:
1. The consumer has committed fraud or a material misrepresentation in regards to the plan;
2. The consumer fails to make the payments required under the plan;
3. The creditor’s security or the creditor’s security interest is threatened by an action or inaction of the consumer;
4. The credit is extended to a credit union’s executive officers and the credit union has placed a due and payable on demand clause.
If the credit union is unable to terminate the home equity plan under section 1026.40(f)(2), section 1026.40(f)(3) may provide a way to freeze/reduce the credit limit. Section 1026.40(f)(3)(i) permits a credit union to freeze a home equity plan if the contract permits a freeze due to reaching the maximum annual percentage rate, and section 1026.40(f)(3)(iii) permits a creditor to freeze/reduce the credit limit if the consumer agrees in writing. For non-contractual freezes, section 1026.40(f)(3)(vi) permits a freeze or reduction in the credit limit when:
1. The value of the dwelling securing the plan has fallen “significantly below” the appraised value of the dwelling;
a. If, based on appraisal used for the purposes of the plan, the difference between the initial available equity and the initial credit limit falls by at least 50%, a significant decline has occurred.
2. There is a material change in the consumer’s financial circumstances, such that the creditor has a reasonable belief that the consumer will be unable to repay the credit;
3. The consumer has defaulted under the loan terms;
4. The government prohibits the creditor from imposing the contracted APR;
5. Government action has reduced the value of the creditor’s security interest to the extent that the value is less than 120% of the credit line; or
6. The NCUA has advised the credit union that further advances would constitute an unsafe and unsound practice.
Credit unions should note that the commentary to the section clarifies that these freezes or reductions in the credit limit are temporary. Once the circumstance that permits a freeze/reduction ceases to exist, the creditor must reinstate the consumer’s credit privileges.
1. The consumer is in default;
2. Title to the property securing the note is transferred by the consumer;
3. The consumer no longer uses the property securing the note as a primary dwelling; or
4. The consumer dies.
When deciding whether to freeze/reduce the credit limit of an account, credit unions should always make sure that they have a defensible reason for doing so that is not prohibited under the contract or state or federal law. Credit union’s should note that while NCUA’s lending regulation, section 701.21, preempts some state laws affecting an FCU’s loan terms and conditions, it does not preempt other areas, such as when a consumer may be declared in default.
About the Author
Keith Schostag joined NAFCU as regulatory compliance counsel in February 2021. In this role, Keith assists credit unions with a variety of compliance issues.