The credit card payment process is shaped in large part by a number of U.S. laws enacted to protect consumers. These laws dictate how interest rates can be set, what information banks are obligated to disclose before a consumer opens an account, and many other important aspects of the payment process, including how disputes and chargebacks work.
The first of these laws, dating back to 1968, is the Truth in Lending Act, which laid out some of the first federal regulations for consumer credit as we use it today. What do merchants need to know about the Truth in Lending Act?
- What is the Truth in Lending Act?
- What is Regulation Z?
- How has the Truth in Lending Act Been Amended?
- How Does the Truth in Lending Act Affect Merchants?
Card payments follow a complex and heavily rule-based system. Merchants and cardholders have to follow the rules laid out by their banks, banks are beholden to the card network rules, and the card networks have to follow the laws of the countries they’re trying to do business in.
For the most part, retail merchants aren’t required to maintain active compliance with these laws—that responsibility falls on the banks and card networks.
However, these laws greatly influence the payment and dispute environment that merchants have to navigate, and it can be worth taking the time to learn about them.
For merchants, the most significant pieces of legislation are the Fair Credit Billing Act of 1974, which created the legal mandate for the chargeback process as it currently exists, and the Electronic Fund Transfer Act of 1978, which established dispute rights for ATM, debit, and ACH transactions. The FCBA originated as an amendment to an earlier federal law, the Truth in Lending Act of 1968.
What is the Truth in Lending Act?
The Truth in Lending Act was written to provide borrowers with better protections in the consumer credit marketplace. The TILA requires that lenders and creditors provide standardized information about fees, interest rates, and payment schedules. It also grants some additional rights to consumers, such as the right of rescission, and prohibits certain lending practices.
TILA regulations cover both open-ended credit lines (credit cards, home equity lines of credit) and closed-end credit lines (fixed-term loans for homes and vehicles).
One key provision of the TILA is the standardized calculation for Annual Percentage Rates. Prior to the act’s passage, some lenders would use misleading methods of calculating auto loan interest rates, tricking consumers into thinking their payments would be lower.
The right of rescission is another important element of the TILA, but not one that affects most retail merchants. It gives borrowers a three-day “cooling off” period during which they can walk away from a loan secured by their home, such as a mortgage refinancing.
Initially, authority to enforce the TILA was granted to the Federal Reserve Board, and the specific implementations of the law were codified as “Regulation Z” in the Code of Federal Regulations. This authority was later transferred to the Consumer Financial Protection Bureau after its creation as part of the banking reforms ushered in by the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, although the FRB is still involved in some of the rule-making aspects.
What is Regulation Z?
Regulation Z, also known as 12 CFR 226, provides the actual details on what lenders are required to do in order to comply with the TILA. It also defines exactly when these regulations are applicable.
Regulation Z applies to loans of at least $61,000 made to individuals (not businesses) that will be paid back in four installments or more. Merchants don’t have to worry about Regulation Z directly, except in rare circumstances, such as a luxury car dealer that offers their own financing.
For loans that meet these criteria, lenders are required to disclose the total cost of credit, which includes interest, fees, finance charges, and any other expenses that will be incurred by taking on the loan. They must also provide a payment schedule, explain how their APR was calculated, and sum up the total amount to be paid, including all principal, interest, and associated charges.
How has the Truth in Lending Act Been Amended?
Consumer credit has changed a lot since the sixties, and the laws have had to play catch-up with shifting business practices, evolving forms of fraud, and new consumer demands. The first major amendment to the TILA, the Fair Credit Billing Act, introduced the first protections specific to the credit card industry.
The FCBA granted consumers the right to dispute erroneous or fraudulent transactions, and limited their liability for unauthorized transactions to $50. This created the chargeback process as we know it.
The TILA received another update in 2009 in the Credit Card Accountability Responsibility and Disclosure Act of 2009, which imposes new rules for issuing banks pertaining to fees, interest rates, billing cycles, due dates, and marketing practices. This amendment was intended to protect consumers from predatory lending practices and did not impact the chargeback process or anything else having to do with merchant-to-consumer interactions.
How Does the Truth in Lending Act Affect Merchants?
The TILA and its most recent major amendment, the CARD Act, primarily concern themselves with the business practices of issuing banks and other consumer credit lenders, not retail merchants. The law that has a major, ongoing impact on merchants’ lives is the FCBA, which established the chargeback process.
Because the law protects cardholders from liability in cases of fraud, the banks and card networks have a choice of two options: they can absorb the costs of fraud themselves, or they can pass liability on to the merchant.
Of course, they choose the latter, which means it is the merchant’s own responsibility to detect and prevent fraudulent transactions to the best of their ability.
Because the FCBA also allows cardholders to dispute transactions based on the premise of merchant fraud, merchants must also protect themselves from customers who abuse the chargeback process by filing false claims. This practice is called “friendly fraud,” and while it can occur for a variety of reasons, some consumers use it as a form of cyber-shoplifting.
The TILA was the first of several federal laws designed to give consumers access to better information and expanded protections in their dealings with lenders. While few of these regulations are aimed directly at merchants, they do play a significant role in shaping the environment merchants have to operate within, particularly with regard to chargebacks.
The frameworks established by these laws are not always favorable to merchants, which is why it is so important to put up your own best defenses against fraud and chargebacks.
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