On July 28 of this year, a group of U.S. senators released a bill intended to protect vulnerable households from entrapment in a cycle of high-cost debt. Their proposal, the Veterans and Consumers Fair Credit Act, would extend to all consumers the protections of the Military Lending Act (MLA), including the MLA’s 36 percent APR cap on most types of non-mortgage consumer credit, and its special rules for calculating the applicable APR. Currently, the MLA applies only to active-duty U.S. servicemembers and their families; the APR for consumer credit generally is calculated using the method set forth in the Truth-in-Lending Act (TILA) and is not subject to a nationwide rate cap. The MLA also requires that both the TILA and military APRs be disclosed to the borrower prior to completion of the credit transaction, and the newly introduced bill incorporates that requirement as well.
A primary objective of the proposed legislation is to eliminate high-priced loans that potentially trap consumers in a cycle of debt or are considered predatory. Payday lenders and other nonbank purveyors of high-cost small dollar loans routinely offer products with an APR that exceeds 300 percent; such products can worsen rather than alleviate the financial difficulties of households in need of cash infusions. However, the proposed law could inadvertently restrict all sources of consumer credit, not just the ones that are problematic. In particular, the 36 percent APR cap may curtail availability to consumers of affordable, short-term small-dollar loans. In addition, compared to the TILA definition of APR, the MLA definition is less transparent to consumers and can include some fees that bear little relation to the true cost of credit.
First, the 36 percent ceiling rate could hamper lenders’ efforts to provide safe and responsible, short-term, small-dollar credit options to households. As explained in a previous BPI research note, operating, administrative and default costs for such small-dollar, short-term loans can translate into relatively high costs on an annualized, per-dollar basis, which in turn may require financial institutions to set a break-even APR well above 36 percent.
Second, broad application of the MLA’s rate cap and APR disclosure requirements would introduce several significant problems for consumers and lenders. Consumers will be confused by the application and disclosure of two, often inconsistent APR calculations, military and TILA. Lenders would be discouraged from offering nonstandard credit card products and useful ancillary services such as credit monitoring, because of esoteric and arbitrary rules dictating when certain fees must be incorporated into the calculation.
So long as the restrictions of the MLA have been confined to a narrow population, these costs associated with the MLA’s separate APR and disclosure requirements have been manageable, such as through lenders waiving fees to active-duty military. However, when the MLA is generalized to the entire population, these costs could harm the overall functioning of the market.
How The Military APR Differs from TILA’s APR
While a monthly payment on an outstanding credit balance typically refers only to the interest rate, the APR is a broader measure of the cost of borrowing money that incorporates the annualized rate of interest on the loan plus other, annualized per-dollar costs attendant to the loan. Under TILA, the latter includes any fees “payable directly or indirectly by the consumer and imposed directly or indirectly by the financial institution either incident to or as a condition of an extension of consumer credit.” Thus, under TILA, the APR includes any interest charges and often other charges such as credit card balance transfer and cash advance fees.
In contrast, the military APR usually includes all fees required to be included under TILA, plus additional fees excluded from the TILA definition. Therefore, the military APR can be considerably higher than the TILA APR. The table below provides a more detailed view of the differences between the MLA and TILA calculations.
Rules for Inclusion of Fees in The APR Calculation: TILA Versus MLA
Included in APR under TILA? 
Included in Military APR?
|Transaction fees||Credit card balance transfer fee; cash advance fee||Yes||Yes, except for credit card fees that are “bona fide and reasonable”|
|Loan origination fee||Yes||Yes|
|Premia for credit life, credit disability or other insurance tied to the extension of credit||No, if the insurance is optional and the lender provided adequate disclosure of the fee and opt-out process||Yes (even if not required for the loan)|
|Fee for debt cancellation contract||No, if the contract is optional and the lender provided adequate disclosure of the fee and opt-out process||Yes (even if not required for the loan)|
|Loan application fee||No, provided it is a standard fee for all applicants||Yes, subject to certain exclusions|
|Participation or membership fee||Annual fee for a credit card plan||No||Yes, except for credit card fees that are “bona fide and reasonable”|
|Fees for optional “credit-related ancillary products and services”||Fees for purchase protection, return protection, for credit monitoring and for identity theft protection||No||Yes|
Note that, in the case of credit card products, whether certain fees are included in the military APR depends on whether the fee amounts are deemed “bona fide and reasonable.” If a fee meets this test, it is not included in the APR calculation. This standard is met if the fee is for a service or benefit extended in good faith (bona fide) and is consistent with market pricing—aligned with fees typically imposed by other creditors for the same or a substantially similar product or service (reasonable). Moreover, the military APR includes a “safe harbor” provision which stipulates that a fee is bona fide and reasonable if it satisfies a specified comparison test.
Also, in the case of credit cards, the military APR allows for exclusion (provided they are bona fide and reasonable) of some occasionally incurred transaction fees that would be included in TILA’s APR. Thus, when such fees are applied, the military APR may be less than the APR as calculated under TILA. Because most consumers rarely make balance transfers or take cash advances, instances when the military APR is less than the TILA APR are apt to be less common than the reverse cases.
Problems With Broad Application of The Military APR
As the chart indicates, there are significant differences between TILA and MLA in how the APR is calculated. By requiring that both APRs be published in connection with consumer credit products, the pending legislation likely would result in considerable consumer confusion.
Moreover, for card issuers, demonstrating whether a fee is “bona fide” and “reasonable” would inevitably result in compliance and enforcement risk, particularly for new or specialized card products. The primary risk is that regulators may decline to label a fee bona fide and reasonable, in which case the affected card accounts would be exposed to breaching the 36 percent APR ceiling proposed in the legislation. Lenders are apt to eliminate product offerings that entail such risk.
Confusion for consumers. TILA, with few exceptions, requires lenders to calculate and disclose the TILA APR to recipients of consumer credit. Requiring lenders to calculate and disclose the military APR (as the basis for a rate cap) in addition to the TILA APR for consumer credit broadly would likely lead to consumer confusion as to which of the disclosed APRs is most relevant to their borrowing decision. That would undermine a primary purpose of the APR, which is to provide greater information and transparency to consumers in making credit decisions.
Compounding this problem, the military APR calculation is more complex than the TILA calculation and, in contrast to the latter, contains data points that do not directly relate to the overall cost of credit; thus, the military APR is less useful for comparing the cost of credit across providers. For example, under TILA, optional credit insurance products are considered separable from the credit itself. Therefore, payments for these are excluded from TILA’s APR, enabling the borrower to focus on the pricing of the credit separately from the premium and other terms associated with the credit insurance offer. Adding the monthly insurance premium to the disclosed APR, as called for by the definition of military APR, irrespective of whether the borrower is required to purchase the insurance, muddles the ability of consumers to make straightforward credit comparisons.
Difficulties around demonstrating “bona fide and reasonable.” To avoid having to include program participation fees in the military APR calculation, credit card issuers are required to demonstrate that those fees are bona fide and reasonable. This requirement can lead to curtailed product offerings.
One undesirable but likely consequence of the need to demonstrate that fees are bona fide and reasonable would be to discourage change or innovation in the market. To exclude participation fees from the military APR calculation in connection with revised or new card programs, the issuer would have to demonstrate that the attendant participation fee is bona fide and reasonable. In particular, the issuer would have to show that they are consistent with market pricing—aligned with fees typically imposed by other creditors for the same or a substantially similar product or service – which becomes hugely challenging if a bank is an innovator and first-to-market with a particular product. Alternatively, if a bank were to include this fee in the APR, it could face significant risk of violating the rate cap for some accounts in any given month, since the fee amount may be large relative to a customer’s account balance in the month the payment comes due, thus temporarily inflating the APR. Hesitancy to innovate is likely to arise in this context.
Similarly, imposition of a rate cap based on the military APR calculation is likely to curtail the variety of specialized card plans available. To the extent that a program provides a distinct combination of benefits or services designed for a niche consumer population, and is priced accordingly, it may be difficult to establish a basis for comparison to determine whether the participation fee is bona fide and reasonable. Again, if a bank were compelled to include this fee in the APR calculation, it could face significant risk of violating the rate cap for some accounts.
Indeed, there is a great variety of credit card plans being offered today. The largest issuers offer numerous differentiated card plans, including some niche programs tailored to cohorts of customers with unique needs or preferences. Many smaller issuers also often offer distinctive card programs targeted to their unique customer base. Banks that currently offer relatively unique card plans would bear a greater burden of having to either establish that their fees are bona fide and reasonable or limit their program offerings.
Consider, as a hypothetical but realistic example, a card program that offers a long string of benefits, including spending rewards; extended warranties, purchase protection; return protection; and travel and entertainment perks and credits such as dining and rideshare credits, trip delay or cancellation insurance, discounts on hotel stays; presale or priority on event tickets, rental car insurance, and baggage insurance, such that there are no or almost no comparable programs to be found. Suppose that in exchange for these valuable benefits the issuer charges an annual fee of $300; because of the lack of comparable programs, it will be very challenging if not impossible to establish that this fee is bona fide and reasonable. In the month that fee comes due, it will be priced into the military APR, and if a customer in that month happens to have only a $500 outstanding balance on the account, the customer’s effective APR will be 60 percent, violating the rate cap.
Another problem likely to arise from use of the military APR for the proposed rate cap is the potential for inconsistency in the granting of bona fide fee exemptions by regulators, should it become more customary for banks to seek such exemptions. The determination of whether a fee is bona fide and reasonable inevitably involves subjectivity (regarding what constitutes substantially similar products). Therefore, exclusion of fees from the APR calculation could vary across banks and card programs based on the potentially subjective determination by regulators or examiners as to what is considered bona fide and reasonable.
Curtailment of ancillary products or services. As noted, fees for optional, credit-related ancillary products (or services), such as credit monitoring and identity theft protection, are required to be incorporated into the calculation of the military APR. Because their inclusion may unwittingly cause the rate cap to be violated, use of the military APR for the proposed 36 percent rate cap could lead lenders to curtail their offerings of credit-related ancillary products, such as credit monitoring and identify theft protection, which often provide significant value to consumers.
Problems of Scale
Of course, one defense of the legislation is that what appears to be working for the military should work for civilians as well. This argument fails to recognize the distinction between applying a rule on a narrow and targeted basis versus applying it to the entire market.
So long as the military APR calculation and associated interest rate cap have been confined to the relatively small and narrow population consisting of active-duty military, banks have been able to mitigate the problems described previously. In general, banks have avoided difficulties by waiving participation fees or fees for ancillary services, or by limiting the ancillary services or types of benefits offered when serving this population, thus largely eliminating differences between the TILA and MLA APRs. For instance, it has been customary for issuers to stay well within the safe harbor bounds in their card program offerings to this population, rather than bear the cost and risk associated with demonstrating that a specialized program is bona fide and reasonable.
While it can be costly to banks to waive fees, the overall cost is absorbable on a small scale, and there is some offsetting benefit from solidifying a longer-term banking relationship with active duty servicemembers, many of whom are young adults. However, once the military APR calculation and associated interest rate cap is applied to the full population of consumer borrowers, waiving fees will no longer be an option, and the problems described in this post would likely proliferate.
The proposal to apply the military APR in the context of a broadly applied rate cap for consumer credit is problematic for several reasons. Consumers likely would be confused by the application of two different APR calculations, innovation in the credit card market likely would be stifled, and banks likely would reduce the variety of credit card plans and other credit products and credit-related ancillary products they offer to consumers. Moreover, inconsistencies are likely to arise in implementing exemptions for “bona fide and reasonable fees” across lending institutions.
So long as the military APR calculation and associated interest rate cap have been confined to the relatively small and narrow population consisting of active-duty military, banks have been able to mitigate these problems. However, once the military APR calculation and associated interest rate cap is applied to the full population of consumer borrowers, the problems described in this post would likely arise, ultimately harming consumer credit availability and choice.
 The proposal also confirms the Consumer Financial Protection Bureau’s authority to conduct examinations to ensure compliance with the cap. The CFPB had stopped supervising for MLA compliance in 2018, but recently announced it was restarting examinations. The MLA does not cover mortgage or home equity lending, or loans secured by an automobile or other personal property which the loan is being used to purchase.
 Per the MLA, the creditor must provide the borrower with certain information before or at the time the borrower becomes obligated on the transaction or establishes an account for the consumer credit, including: (1) A statement of the MAPR applicable to the extension of consumer credit; (2) Any disclosure required by Regulation Z, which shall be provided only in accordance with the requirements of Regulation Z that apply to that disclosure; and (3) A clear description of the payment obligation of the covered borrower, as applicable. See the CFPB’s MLA Interagency Examination Procedures for further details.
 This BPI infographic provides some illustrative APR calculations for small dollar loans.
 As described further herein, so long as the military APR calculation and associated interest rate cap have been confined to the relatively small and narrow population consisting of active-duty military, banks have been able to mitigate the problems discussed herein that likely would arise if that calculation and interest rate cap were applied to all consumer credit products.
 The Federal Reserve Board’s Regulation Z, which implements TILA, specifies which fees to include in the APR calculation.
 See the FDIC Consumer Compliance Examination Manual for further details on how the TILA finance charge and APR are calculated.
 If any single fee being charged for a credit card is not bona fide, and a finance charge is also imposed, then any other fees that may be bona fide are no longer exempt from the military APR calculation for credit card plans.
 Application fees are included in the military APR except in connection with certain short-term, small amount loans, and except for a bona fide and reasonable fee for credit card applicants.
 Purchase protection covers the replacement cost for items purchased using the card if the items are damaged, lost or stolen within a specified period after purchase, subject to certain caveats. Return protection provides for refunds on eligible items that the consumer attempts to return to a retailer within a specified period after purchase and that the merchant won’t take it back.
 See the NCUA Supervisory Letter, “Complying with Recent Changes to the Military Lending Act Regulation,” for further details.
 The safe harbor provision is met if the fee “is less than or equal to the average amount of a fee charged for the same, or a substantially similar, product or service charged during the preceding three years by five or more creditors having U.S. credit cards in force of at least $3 billion.” The $3 billion threshold can be met based either on loan amounts currently outstanding or on the amounts initially extended on accounts with an outstanding loan balance. A fee can be deemed bona fide and reasonable even if the safe harbor criterion is not met, depending on the credit limit in effect or credit made available; the services offered under the account; or other factors that might justify the reasonableness of the fee.
 For instance, up-front cash advance or balance transfer fees, provided they are determined to be “bona fide and reasonable,” are excludable from the military APR calculation, although they would be included in the TILA calculation.
 Insurance offers often cannot be compared via monthly premium payments alone but require consideration of the specific benefits and limitations attached to the insurance policy, such as the number of payments covered in the event of job loss or disability.
 The American Financial Services Association in 2020 published an issue brief expressing a similar viewpoint.
 So long as the restrictions of the MLA have been confined to a narrow population, it has been customary for issuers to stay well within the safe harbor bounds in their product offerings to this population. However, when the MLA is generalized to the entire population, it could become more common for banks to first pursue the bona fide exemption before choosing to limit their product offerings.