The Required Deposit Disclosure for CD Secured Loans

When reviewing deposit secured loans, one of the most common audit violations relates to the “required deposit” disclosure.  This lower risk finding is often found in audit and exam reports because it is a fairly common finding and is extremely easy to identify - known as “low hanging fruit.”  Financial institutions can ensure they don’t fall victim to this easy to avoid issue by fully understanding the rules for the required deposit disclosure.

The Required Deposit Disclosure Rules

The required deposit disclosure requirements are found in 1026.18(r) of Regulation Z, where the rules state that a special disclosure must be provided on certain deposit secured loans. In simple terms, the rules state that certain deposit secured loans, such as CD secured loans, must include a statement (disclosure) that the annual percentage rate does not reflect the effect of the required deposit.  This statement is found in the Fed box of the Truth in Lending (TIL) disclosure. Logistically, most financial institutions will have a checkbox on their loan operating system (LOS) that they chec to populate the “required deposit” statement on the TIL. Other times, a private template on the LOS will have this disclosure hard coded for each loan of a certain product type, such as CD secured loans.

When the Required Deposit Disclosure is Required

One of the most confusing things about the required deposit disclosure requirements is that the disclosure is not required for every deposit secured loan.  In simple terms, the required deposit disclosure is required for each deposit secured loan except for three exclusions:

  • An escrow account for items like taxes, insurance or even repairs

  • A deposit that earns not less than 5 percent per year

  • Payments under a Morris Plan

As most deposit secured loans don’t utilize a Morris Plan or an escrow account, the 5% requirement is the most common exclusion that would apply.  The commentary explains it a bit clearer than the regulation itself as it says that the disclosure isn't required “when a deposit earns at least 5 percent interest per year.”

Now, it is important to understand that while the rules specifically exclude deposit accounts that earn at least 5% interest per year, it can be logistically very difficult to utilize the exemption.  For example, it is easier for a lender to remember to include the required deposit disclosure for each deposit secured loan than for them to not include it if the interest rate of the collateral is more than 5% per year, but to include it if the rate is less than 5%.  Therefore, the best practice to avoid having issues with this low hanging fruit is to train lending staff to include the required deposit disclosure for all deposit secured loans.

The Required Deposit Disclosure Regulation and Commentary

The actual rules for the required deposit disclosure are found in 1026.18(r) of Regulation Z, and are as follow:

(r) Required deposit. If the creditor requires the consumer to maintain a deposit as a condition of the specific transaction, a statement that the annual percentage rate does not reflect the effect of the required deposit. A required deposit need not include, for example:

(1) An escrow account for items such as taxes, insurance or repairs;

(2) A deposit that earns not less than 5 percent per year; or

(3) Payments under a Morris Plan.

The commentary to Regulation Z provides the official interpretation to the rules and is as follows:

18(r) Required Deposit

1. Disclosure required. The creditor must inform the consumer of the existence of a required deposit. (Appendix H provides a model clause that may be used in making that disclosure.) Section 1026.18(r) describes 3 types of deposits that need not be considered required deposits. Use of the phrase “need not” permits creditors to include the disclosure even in cases where there is doubt as to whether the deposit constitutes a required deposit.

2. Pledged account mortgages. In these transactions, a consumer pledges as collateral funds that the consumer deposits in an account held by the creditor. The creditor withdraws sums from that account to supplement the consumer's periodic payments. Creditors may treat these pledged accounts as required deposits or they may treat them as consumer buydowns in accordance with the commentary to §1026.17(c)(1).

3. Escrow accounts. The escrow exception in §1026.18(r) applies, for example, to accounts for such items as maintenance fees, repairs, or improvements, whether in a realty or a nonrealty transaction. (See the commentary to §1026.17(c)(1) regarding the use of escrow accounts in consumer buydown transactions.)

4. Interest-bearing accounts. When a deposit earns at least 5 percent interest per year, no disclosure is required under §1026.18(r). This exception applies whether the deposit is held by the creditor or by a third party.

5. Morris Plan transactions. A deposit under a Morris Plan, in which a deposit account is created for the sole purpose of accumulating payments and this is applied to satisfy entirely the consumer's obligation in the transaction, is not a required deposit.

6. Examples of amounts excluded. The following are among the types of deposits that need not be treated as required deposits:

i. Requirement that a borrower be a customer or a member even if that involves a fee or a minimum balance.

ii. Required property insurance escrow on a mobile home transaction.

iii. Refund of interest when the obligation is paid in full.

iv. Deposits that are immediately available to the consumer.v. Funds deposited with the creditor to be disbursed (for example, for construction) before the loan proceeds are advanced.

vi. [Reserved]

vii. Escrow of loan proceeds to be released when the repairs are completed.

 

2019 Regulation Z Thresholds

2018 Regulation P Amendments

2018 Regulation P Amendments

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