By Ashlie Nutter, CPA/ABV/CFF, manager in the Audit Department at MBAF
Members of our military make sacrifices every day while serving our nation and protecting our freedoms. In recognition of that service, the government provides many benefits to veterans, among them protections for service members financing large purchases. Such protections are found under the Military Lending Act (MLA).
The MLA was enacted by Congress in 2006 and implemented by the Department of Defense (DoD) in 2007 with the intention to protect active duty members of the military, their spouses, and dependents from predatory lending practices. The Act established new limitations and disclosure requirements for transactions involving the extension of consumer credit as defined under Regulation Z of the Truth in Lending Act (TILA) to such covered borrowers. The automotive industry therefore generally considered itself exempt from the MLA as TILA specifically excluded from its definition of consumer credit any credit extended on the purchase of a motor vehicle that is secured by that vehicle.
However, in December 2017, the DoD issued new interpretative guidance on this exclusion. The question was raised whether the exception was still relevant if the amount financed exceeded the purchase price of the vehicle. The DoD responded that if “credit-related costs” are financed, the exclusion did not apply and the transaction was subject to requirements under the MLA. This response generated confusion and concern. The question on everyone’s mind centered around what constituted “credit-related costs.” The answer lay in the language of the MLA.
Under the Act, the total charges are expressed through an annualized rate referred to as the Military Annual Percentage Rate (MAPR), which may not exceed 36 percent. The Act broadly defines such charges as “interest, fees, and charges imposed for credit insurance, debt cancellation and suspension, and other credit-related ancillary products sold in connection with the transaction.”
Based on this, financing of “ancillary products” as part of a vehicle sale would force compliance with the MLA.
The MLA and GAP Insurance
The ancillary product at the center of this discussion is Guaranteed Auto Protection or GAP insurance. When a customer purchases a vehicle, particularly a new vehicle, the vehicle begins depreciating as soon as it is driven off the lot. If a financed vehicle becomes a total loss due to theft or damage soon after purchase, the borrower may owe more on the vehicle than will be covered by his or her insurance. GAP insurance, as its name implies, covers the “gap” between what is owed on the vehicle and any insurance proceeds.
Dealerships often roll the additional cost of GAP insurance into the overall vehicle loan. Under the new guidance released by the DoD, any loan made to an active duty service member, their spouse, or dependents that includes GAP, must now comply with the 36 percent MAPR mandate as well as other disclosure requirements under the MLA.
So, what options do dealers have available to avoid falling under the requirements of the MLA? The interpretative guidance did not clarify whether dealerships could continue to sell ancillary products outside of the MLA requirements if those products were not financed. Therefore, this leaves automotive dealers with limited options. The first and most drastic option available is to stop offering GAP and credit insurance products altogether. This would require no further action as there would be no need to comply with the MLA. Dealers can alternatively stop selling these products to just active duty service members, their spouses, and dependents. This alternative, however, would require management to establish processes to identify such individuals.
These changes have created concerns regarding fair lending practices, including whether it is discriminatory to limit products and financing options available to service members. This is particularly relevant for GAP insurance which could be beneficial in the event of a total loss. Additionally, as GAP and other credit insurance products have traditionally been an F&I profit center for many dealerships, it is obvious that either of these options would result in reduced profitability that could ultimately factor into valuations going forward.
What Happens Next?
Dealers that elect to continue selling GAP and other credit insurance products to service members must comply with the MLA. Failure to do so can result in civil liability for actual damages, punitive damages, equitable or declaratory relief, and attorney’s fees. There is criminal liability including fines and imprisonment for knowing violations.
Therefore, it is recommended that dealers maintain a safe harbor by checking the individual or their military sponsor’s status through the MLA website when the application is submitted or up to 30 days prior to submission. The MLA website will immediately send a certification signed by an official showing the individual or their military sponsor’s status that can be used to determine the need for MLA compliance on individual transactions.
MBAF is a Top 40 accounting and advisory firm serving domestic and international clients. Ashlie Nutter is a manager in the MBAF Audit Department. She can be reached at (305) 373-5500 ext. 7307 or firstname.lastname@example.org.