This article tells you what the Credit Practices Rule is, what it requires, who must comply, and what transactions are covered.

What is the Credit Practices Rule?

The Credit Practices Trade Regulation Rule is a federal law that governs certain aspects of the extension of credit from a business to its customers.

What the Credit Practice Rule Requires

The Credit Practices Rule has three major provisions. First, it prohibits creditors from using certain contract provisions that the Federal Trade Commission found to be unfair to consumers. The prohibited contract provisions are confessions of judgment, waivers of exemption, wage assignments, and security interests in household goods (these prohibited provisions are explained in more detail below, and examples of each are provided). Second, the Rule requires creditors to advise consumers who cosign obligations about their potential liability if the other person fails to pay. Third, the Rule prohibits late charges in some situations.

Who Must Comply

This Rule applies to all creditors subject to the jurisdiction of the Federal Trade Commission. It includes all finance companies, retailers (such as auto dealers and furniture and department stores), and credit unions that offer consumer credit contracts. Similar rules have been passed by the Federal Reserve Board and the Federal Home Loan Bank Board for banks, savings and loan associations, and other institutions under their jurisdiction.

What Transactions are Covered

The Rule covers all consumer credit transactions, except those involving the purchase of real estate. It covers loans made to consumers who purchase goods or services for personal, family, or household uses, even though those loans may be secured by real estate owned by the consumers. The Rule also applies to the sale of goods or services under lease-purchase plans.

However, contracts with your customers signed before March 1, 1985, which contain the four prohibited provisions -- confessions of judgment, waivers of exemption, wage assignments, or security interests in household goods -- are enforceable and not in violation of the Rule. Similarly, you may collect debts from cosigners who became obligated before the effective date of the Rule, even though they did not receive the notice that the Rule requires. On the other hand, after March 1, 1985, you may not collect late fees that are prohibited by the Rule, even if the contract was signed before that date.

How Penalties are Assessed

The Federal Trade Commission can sue violators of the Credit Practices Rule in federal court. The court can impose civil penalties of up to $10,000 for each violation and can issue an order prohibiting further violations.

Prohibited Contract Provisions

Certain consumer provisions, which you may have used in consumer credit contracts, are now prohibited. These include: confessions of judgment; waivers of exemption; wage assignments; and security interests in household goods. If your consumer credit contracts contain language that requires a debtor to confess judgment, to waive exemptions, to assign wages or income, or to give you a blanket security interest in all household goods, you should remove that language from all contracts signed on or after March 1, 1985. If you have not done so, you are in violation of the Rule.

Confessions of Judgment

In states that have not specifically outlawed the practice, certain consumer credit contracts have contained language taking away certain rights that consumers being sued would ordinarily have. These include the right to receive notice of the suit, to appear in court, and to raise any defenses that they may have. This provision, usually called a "confession of judgment," allowed judgment to be entered for the creditor automatically when the creditor sued the debtor for breach of the contract. The Rule now prohibits creditors from including confession of judgment provisions, such as the following, in consumer credit contracts:

To secure payment hereof, the undersigned jointly and severally irrevocably authorize any attorney of any court of record to appear for any one or more of them in such court in term or vacation, after default in payment hereof and confess a judgment without process in favor of the creditor hereof for such amount as may then appear unpaid hereon, to release all errors which may intervene in any such proceedings, and to consent to immediate execution upon such judgment, hereby ratifying every act of such attorney hereunder.

The Rule's prohibition against "confessions of judgment," does not prohibit power-of-attorney provisions that allow you to repossess and sell collateral, as long as these provisions do not interfere with the consumer's right to be heard in court. The Rule also does not prohibit a consumer from acknowledging liability after suit has been filed and the consumer has been duly notified. The Rule is not intended to interfere with whatever rights you have to repossess secured property.

Waivers of Exemption

Previously, some consumer credit contracts contained "waiver of exemption" provisions that permitted creditors to seize (or threaten to seize) specific possessions or possessions of a specified value, even if state law treated them as exempt from seizure. Every state has a law that defines certain property (generally, property considered necessities) that a debtor is allowed to keep even if a creditor sues and obtains a judgment. By signing a waiver of exemption, a debtor made that property available to a creditor who obtained a judgment to satisfy a debt. Clauses such as the following are no longer permissible under the FTC Rule:

Each of us hereby both individually and severally waives any or all benefit or relief from the homestead exemption and all other exemptions or moratoriums to which the signers or any of them may be entitled under laws of this or any other State, now in force or hereafter to be passed, as against this debt or any renewal thereof.

Wage Assignments

Previously, if consumers did not pay as agreed, some consumer credit contracts permitted creditors to go directly to the consumers' employers to have their wages, or some part of them, paid directly to the creditors. Under the Rule's prohibition against "wage assignments," your consumer contracts may not provide for the irrevocable advance assignment to you of any money due consumers because of their personal services (usually through employment) if they do not pay as agreed. The Rule prohibits irrevocable assignments to creditors of salaries, commissions, bonuses, pensions, and disability benefits, as well as wages due to consumers.

Below is an example of a wage assignment provision that is no longer permitted in consumer credit contracts:

If default be made in payment of the above-described debt, which is the time balance (Total of Payments) due on a retail installment contract, each of the undersigned hereby assigns, transfers and sets over to the above-named assignee, wages, salary, commissions, bonuses and periodic payments pursuant to a retirement or pension plan due or subsequently earned from his present employer or from any future employer within a period of two (2) years from the date of execution hereof. This assignment shall remain effective as to all of the undersigned Debtors.

Security Interests in Household Goods

Previously, some consumer credit contracts contained non-purchase money security agreements that allowed a creditor to repossess many household goods in the consumer's home if the consumer did not pay as agreed. Now your contracts cannot use language, such as the following, that provide for repossession of certain household goods specified in the Rule:

This note is secured by a security interest in consumer goods consisting of all household goods, furniture, appliances, and bric-a-brac, now owned and hereinafter acquired, including replacements, and located in or about the premises at the Debtor's residence (unless otherwise stated) or at any other location to which the goods may be moved. In addition, all other goods and chattels of like nature hereafter acquired by the Debtor and kept or used in or about said premises and substituted for any property mentioned. Proceeds and products of the collateral are also covered.

The Rule's definition of "household goods" includes household necessities such as clothing, appliances, and linens, and some items of little economic value to you, but of unique, personal value to the consumer. These may include items such as family photographs, personal papers, the family Bible, and household pets. Excluded from the definition of household goods are:

Works of art, electronic entertainment equipment (except one television and one radio), items acquired as antiques (more than 100 years old), and jewelry (except wedding rings).

Notice to Cosigners

If you require a cosigner for a loan applicant who does not meet your standards of creditworthiness or for debtors in default, the Rule requires you to inform each cosigner of the potential liability involved before the cosigner becomes obligated for the debt. You must use the following statement:

Notice to Cosigner

You are being asked to guarantee this debt. Think carefully before you do. If the borrower doesn't pay the debt, you will have to. Be sure you can afford to pay if you have to, and that you want to accept this responsibility.

You may have to pay up to the full amount of the debt if the borrower does not pay. You may also have to pay late fees or collection costs, which increase this amount. The creditor can collect this debt from you without first trying to collect from the borrower.

The creditor can use the same collection methods against you that can be used against the borrower, such as suing you, garnishing your wages, etc. If this debt is ever in default, that fact may become a part of your credit record.

This notice is not the contract that makes you liable for debt.

If a state statute or regulation requires a different notice to cosigners, you may include that notice on the document if it is not inconsistent with the notice required by the Rule. If a statement in the FTC notice (such as one that says you can collect from the consigner without first trying to collect from the primary debtor) is inaccurate under sate law, you may omit it from the notice used in that state.