In-House Payment Plans and When They Become Credit

Why this matters

"We'll let you pay it off over six months" feels like a favor, and for a shop that does it now and then it usually is. Do it as a habit and the favor has a legal name: you are extending consumer credit, and federal law expects a disclosure statement you have probably never printed, while your state may cap what you charge or expect a license you do not hold. The line is not about how generous the plan is. It is about two counts any office can make, and most shops cross it without knowing there was one.

The two-part test in Regulation Z

The Truth in Lending Act (TILA) and Regulation Z, 12 CFR Part 1026, govern consumer credit. Regulation Z at 1026.1(c) says it applies to anyone who offers or extends credit when four conditions are all met:

1. the credit is offered or extended to consumers;
2. the offering or extension is done regularly;
3. the credit is subject to a finance charge, or is payable by written agreement in more than four installments;
4. the credit is primarily for personal, family or household purposes.

Condition 3 is the one with an OR in it, and it is where shops get caught. A plan with no interest at all is still credit under Regulation Z if it runs to five or more installments by written agreement. A plan of only two payments is still credit if it carries a finance charge.

Condition 2 has a number too. Regulation Z's definition of creditor at 1026.2(a)(17) treats a person as extending credit regularly if it did so more than 25 times in the preceding calendar year (more than 5 times for credit secured by a dwelling). If you did not cross that in the prior year, the same count applies in the current year once you cross it. A shop running two or three plans a month is over the line by November.

This is not legal advice, and the definitions have edges this card does not cover, so read the rest as the shape of the rule and take a specific plan to your attorney or accountant before you build a program around it.

What counts as a finance charge

A finance charge under 1026.4 is any charge payable as an incident to or a condition of the extension of credit. Three things in a typical shop plan look harmless and may be one:

• A plan price. If customers who pay over time are quoted a higher total than customers who pay at completion, the difference is generally a finance charge even if nobody calls it interest.
• A setup or administration fee charged only to plan customers.
• Interest by any other name. "A small monthly service charge on the balance" is interest.

One thing usually is not: a late fee for an actual delinquency, which 1026.4(c)(2) excludes from the finance charge, provided the plan states it and your state permits it. Cash discounts are a trap in the other direction, because Regulation Z lists a discount offered to induce payment by means other than credit among its examples of a finance charge, with exceptions; do not build a "pay now and save" plan structure without having someone read that section against it.

Counting installments has its own rule worth knowing: a down payment is not an installment. A plan of 25 percent today and three more payments is four installments, not four plus one.

Plan A:  25% at completion, then 3 monthly
         installments, no fee, no price change
         installments counted ......... 3
         finance charge ............... none
         -> outside Regulation Z

Plan B:  6 equal monthly installments, no fee
         installments counted ......... 6
         finance charge ............... none
         -> credit: more than four installments

Plan C:  2 monthly installments, plan price 5%
         above the completion price
         installments counted ......... 2
         finance charge ............... the 5%
         -> credit: finance charge present

What being a creditor costs you

If your plans are credit and you are a creditor, each one needs a closed-end disclosure under 1026.17 and 1026.18, given before the customer is bound: the amount financed, the finance charge, the annual percentage rate, the total of payments, the payment schedule, any late charge and security interest, and a handful of other items, with the APR and finance charge more conspicuous than the rest. A zero-interest plan still gets a disclosure showing a zero finance charge and a zero APR.

That is the federal layer. The state layer is usually heavier.

• Rate caps. Most states set a maximum rate on consumer installment credit, through a usury statute or a retail installment sales act, and the cap can depend on the size and length of the contract.
• Retail installment sales acts. Many states regulate a seller who sells on installments directly, with their own contract form, disclosures, and cancellation and late-fee rules. California's Unruh Act, Civil Code 1801 and following, and the retail installment provisions of the Texas Finance Code are two examples that reach a seller financing its own sales.
• Licensing. Some states require a seller who finances its own sales, or who makes consumer loans, to register or hold a license. Whether a plan of yours needs one turns on how your state defines the activity, and there is no national answer.

If you later sell the plan contracts to a finance company, the FTC Holder Rule notice must be in them too. See related: The Holder Rule and Why Your Workmanship Follows the Loan.

The simpler alternatives

Most shops do not need a credit program. They need to stop losing jobs to customers who cannot pay a large ticket at once. Four structures do that without crossing the Regulation Z line, and each has its own catch.

Four or fewer installments, no finance charge, same price. The cleanest one. Write it down, keep the price identical to the pay-at-completion price, and stop at four. The catch is that a four-payment plan on a large ticket still leaves you carrying most of the job for three months. See related: Negotiating a Payment Plan That Holds.

Progress billing tied to the work. A deposit, a payment at rough-in, a payment at completion. Payments that fall due as work is performed generally do not defer a debt for work already done, which is the core of what credit is. The catch is that it fits multi-stage jobs, not a one-day water heater swap, and your state may cap deposits and progress payments. See related: Statutory Caps on Down Payments and Progress Payments.

A third-party lender. The lender carries the credit, the disclosures and the licensing. The catch is the dealer fee, the Holder Rule, and fair-lending duties at the point of sale. See related: Arranging Customer Financing and the Truth in Lending Act.

A card. Many customers have available credit on a card already. The catch is the processing cost, and that it does not help the customer whose card is the problem.

Worked example: the six-month habit

A five-tech plumbing shop started offering payment plans two years ago, when a customer could not cover a sewer line repair. It went well, the office kept offering it, and nobody revisited the terms.

The count. At year-end the office manager runs a report of invoices with a payment schedule attached. Last calendar year: 31 plans. Every one was 6 equal monthly payments, no interest, signed on the shop's own one-page agreement. This year to date: 19.

Applying the test. Consumers, yes: all residential. Personal or household purpose, yes. More than four installments by written agreement, yes: six. Regularly, yes: 31 is more than 25 in the preceding calendar year. All four conditions met, so every one of this year's 19 plans was consumer credit extended by a creditor, without a single TILA disclosure.

The second problem in the same file. Eleven of the 31 plans from last year had a line reading "plan administration fee: 3 percent of balance." The office added it after a customer paid late. That is a charge imposed as a condition of the credit, so it is a finance charge on those 11, and on those 11 the shop was also charging something its state's installment law may cap or may require a license to charge.

The fix, in order.

1. The owner stops offering the six-month plan that day. Plans already running continue on their existing terms; nobody is told their agreement is void.
2. The administration fee is dropped from every open plan in writing, and the owner asks the shop's attorney whether the fees already collected on the 11 should be refunded under state law. That is the attorney's call, not this card's.
3. The new standard plan is Plan A from the box above: 25 percent at completion, three monthly installments, same price, a stated late fee only if the attorney confirms the state allows it.
4. Jobs too large for that go to the shop's third-party lender, offered on every quote. See related: Equal Credit and the Financing Conversation.
5. The office adds a hard stop to the invoice template: a payment schedule with more than four installments, or any fee tied to the schedule, cannot be saved without the owner's approval.

What would change the answer. If the shop had run 20 plans last year instead of 31, it would not have been a creditor on the prior-year count, though it would become one the moment it passed 25 in the current year. If every plan had been for a landlord's rental units, the consumer-purpose condition fails and Regulation Z drops out, but state commercial lending and usury law may not. And a state retail installment act can reach a seller whose plans fall outside Regulation Z altogether, so the federal escape is not a state escape; California's Unruh Act, for example, uses its own definitions, so check them against your plan rather than assuming the four-installment line carries over.

How to verify you have this right

Run two counts on last calendar year: plans with more than four installments, and plans with any fee, rate or price difference tied to paying over time. If the total of plans meeting either condition is more than 25, you have been extending consumer credit. Then read your plan agreement and confirm the price on it matches your pay-at-completion price to the cent. If either check fails, stop the plan type before you fix the paperwork, not after.

References

• Truth in Lending Act, 15 USC 1601 et seq.
• Regulation Z, 12 CFR Part 1026 (coverage at 1026.1(c), creditor definition at 1026.2(a)(17), finance charge at 1026.4, closed-end disclosures at 1026.17 and 1026.18)
• California Unruh Act (retail installment contracts), Civil Code 1801 and following
• See related: Negotiating a Payment Plan That Holds
• See related: Statutory Caps on Down Payments and Progress Payments