When a Payment Plan Becomes Credit Under Federal Law

Answer first: credit is the right to defer payment, and nothing more elaborate

Regulation Z's definition is eleven words. Credit means the right to defer payment of debt or to incur debt and defer its payment.

Consumer credit is defined as credit offered or extended to a consumer primarily for personal, family or household purposes. Consumer is defined as a cardholder, or a natural person to whom consumer credit is offered or extended.

Nothing in either definition requires interest, a contract calling itself a loan, or an entity calling itself a lender. Splitting a price into later payments is deferring payment of debt. Whether the arrangement then carries the regulation's disclosure duties turns on a separate definition — the definition of creditor — and that is where the substance sits.

The distinction is easy to lose. An arrangement can be credit under the definition while the party offering it is not a creditor under the definition, in which case the closed-end disclosure obligations addressed to creditors do not attach to it.

The two tests inside the definition of creditor

The regulation defines creditor as a person who regularly extends consumer credit that is subject to a finance charge or is payable by written agreement in more than four installments, not including a down payment, and to whom the obligation is initially payable, either on the face of the note or contract, or by agreement where there is no note or contract.

Three conditions have to line up. The person must regularly extend consumer credit. The credit must be subject to a finance charge, or payable by written agreement in more than four installments. And the obligation must be initially payable to that person.

The four-installment test is the one that governs pay-later arrangements with no stated interest. An arrangement with no finance charge that is payable in four installments or fewer does not satisfy that branch. The same arrangement stretched to five installments does. The number is written into the definition, and the down payment is expressly not counted.

The definition contains further limbs for card issuers. For purposes of the discount, transaction-time finance charge and refund-crediting provisions, a person that honors a credit card is a creditor. For most of the open-end subpart, any card issuer that extends either open-end credit or credit that is not subject to a finance charge and is not payable by written agreement in more than four installments is a creditor. And for much of the open-end subpart and the closed-end subpart, any card issuer that extends closed-end credit subject to a finance charge or payable in more than four installments is a creditor.

So a card issuer can be a creditor for some purposes and not others, and the paragraph that applies decides which rules follow.

What makes something a finance charge

The regulation defines the finance charge as the cost of consumer credit as a dollar amount. It includes any charge payable directly or indirectly by the consumer and imposed directly or indirectly by the creditor as an incident to or a condition of the extension of credit. It does not include any charge of a type payable in a comparable cash transaction.

That last clause is the operative screen. A charge that a cash buyer would also pay is not a finance charge, no matter how it is labeled. A charge that appears only because payment is being deferred is one.

Third-party charges are pulled in under two conditions. The finance charge includes fees and amounts charged by someone other than the creditor if the creditor requires the use of a third party as a condition of or an incident to the extension of credit, even if the consumer can choose the third party — or if the creditor retains a portion of the third-party charge, to the extent of the portion retained.

The examples list is long and includes interest and time price differential; service, transaction, activity and carrying charges; points, loan fees, assumption fees and finder's fees; appraisal, investigation and credit report fees; premiums for guarantees or insurance protecting the creditor against default; premiums for credit life, accident, health or loss-of-income insurance written in connection with a credit transaction; and charges or premiums paid for debt cancellation or debt suspension coverage, whether or not the coverage is insurance under applicable law.

One entry cuts the other way and is worth noting alongside the cash-discount rules elsewhere in the regulation: discounts for the purpose of inducing payment by a means other than the use of credit are listed as finance charges.

What is excluded, and why the exclusions matter

The regulation lists charges that are not finance charges, and several of them appear routinely on consumer accounts.

Application fees charged to all applicants for credit, whether or not credit is actually extended, are excluded. So are charges for actual unanticipated late payment, for exceeding a credit limit, or for delinquency, default or a similar occurrence.

Charges imposed by a financial institution for paying items that overdraw an account are excluded, unless the payment of such items and the imposition of the charge were previously agreed upon in writing — with stated carve-outs for credit offered in connection with a prepaid account and for certain overdraft credit.

Fees charged for participation in a credit plan, whether assessed on an annual or other periodic basis, are excluded, with a carve-out for a fee to participate in a covered separate credit feature accessible by a hybrid prepaid-credit card.

The exclusions matter for the same reason the definition of creditor does. Where a charge is excluded from the finance charge, it does not by itself make the credit subject to a finance charge, and the four-installment branch becomes the only remaining route into the definition of creditor.

There is also a separate treatment of voluntary credit insurance premiums, and of insurance and debt cancellation or debt suspension coverage, which may be excluded where the regulation's stated conditions are met.

Open-end and closed-end, and why the label decides the disclosures

The regulation defines open-end credit as consumer credit extended by a creditor under a plan in which three things are true: the creditor reasonably contemplates repeated transactions; the creditor may impose a finance charge from time to time on an outstanding unpaid balance; and the amount of credit that may be extended during the term of the plan, up to any limit the creditor sets, is generally made available to the extent that any outstanding balance is repaid.

Closed-end credit is defined by subtraction: consumer credit other than open-end credit.

That fork decides which disclosure regime applies. Open-end credit runs on account-opening disclosures and periodic statements. Closed-end credit runs on a set of transaction disclosures before consummation. A plan that revolves and a plan that finances one purchase in installments are different animals under the regulation even where the monthly amount looks the same.

Two supporting definitions come along with the fork. Consummation means the time that a consumer becomes contractually obligated on a credit transaction — the moment several other timing rules key to. And a billing cycle is the interval between the days or dates of regular periodic statements, which must be equal and no longer than a quarter of a year, with an interval treated as equal if the number of days does not vary more than four days from the regular day or date.

None of this decides whether any particular health program is offering credit. It sets out the questions: is payment being deferred, is a finance charge imposed, is the obligation payable in more than four installments by written agreement, is the obligation initially payable to the party offering it, and does the arrangement revolve.