One of our auto loan customers is an active duty military servicemember. He would like to trade in his existing car and finance the purchase of a new car. The trade-in value of the current car will not cover the balance on his existing loan (he has “negative equity”), so the proceeds of the new loan will cover the purchase price of the new car, plus a small amount to pay off the remainder of the existing loan balance. Because a portion of the proceeds will be used to pay off an existing car loan, does the Military Lending Act apply to the new loan?

Aug 10, 2017

—

We believe that this loan could be treated as an auto purchase loan, which would be exempt from the Military Lending Act (MLA)’s consumer protections. But there is some ambiguity on this point. We contacted the Department of Defense (DOD) to pose this question and were informed that the DOD is aware of this ambiguity and plans to issue clarifying guidance.

The MLA’s consumer protections apply to consumer credit transactions with active duty military servicemen and their dependents. Auto purchase loans are excluded from the MLA if they are “expressly intended to finance the purchase of a motor vehicle when the credit is secured by the vehicle being purchased.” We believe that a loan financing the purchase of a new car that includes the payoff amount for the borrower’s previous car loan would qualify as an auto purchase loan.

However, the Department of Defense (DOD) muddied the waters when it issued an FAQ discussing a related exception for purchase money personal property loans which concluded that the exception would not include a hybrid purchase and cash advance loan. The FAQ stated that a loan qualifying for the purchase money exception “must finance only the acquisition of personal property” and cannot provide “additional financing that is unrelated to the purchase.” In your case, the loan would not be providing a cash advance, so we do not believe that it would be subject to the carve-out for hybrid loans described in the FAQ. However, the loan is not purely a purchase money loan, as it also would be financing the payoff of the existing car loan.

Due to this ambiguity, the DOD representative we spoke with told us they have received similar questions from several lenders, trade associations and even other regulators, and its forthcoming guidance should address this question. However, the DOD representative could not say what this guidance will be, nor could he predict when it will be issued. The DOD representative was willing to engage in what he termed a “philosophical” discussion of the rule, and our impression from that discussion was that the DOD intends to treat the payoff of an existing car loan in the course of financing a new purchase as sufficiently related to the purchase transaction (similar to treating items that would be paid in a cash transaction for the purchase of a car or other personal property). However, without seeing this guidance in writing, we cannot provide a definitive answer, and your bank will need to make its own determination based on the DOD’s existing guidance.

For resources related to our guidance, please see:

Military Lending Act Regulations, 32 CFR 232.2 (“This part applies to consumer credit extended by a creditor to a covered borrower, as those terms are defined in this part.”)

Military Lending Act Regulations, 32 CFR 232.3(f)(2)(ii) (“Consumer credit does not mean . . . [a]ny credit transaction that is expressly intended to finance the purchase of a motor vehicle when the credit is secured by the vehicle being purchased . . . .”)

Interpretive Rule, Military Lending Act Frequently Asked Questions, 81 Fed. Reg. 58840, 58841 (August 26, 2016)

“2. Does credit that a creditor extends for the purpose of purchasing personal property, which secures the credit, fall within the exception to ‘consumer credit’ under 32 CFR 232.3(f)(2)(iii) where the creditor simultaneously extends credit in an amount greater than the purchase price?

“Answer: No. Section 232.3(f)(1) defines ‘consumer credit’ as credit extended to a covered borrower primarily for personal, family, or household purposes that is subject to a finance charge or payable by written agreement in more than four installments. Section 232.3(f)(2) provides a list of exceptions to paragraph (f)(1), including an exception for any credit transaction that is expressly intended to finance the purchase of personal property when the credit is secured by the property being purchased. A hybrid purchase money and cash advance loan is not expressly intended to finance the purchase of personal property, because the loan provides additional financing that is unrelated to the purchase. To qualify for the purchase money exception from the definition of consumer credit, a loan must finance only the acquisition of personal property. Any credit transaction that provides purchase money secured financing of personal property along with additional ‘cash-out’ financing is not eligible for the exception under § 232.3(f)(2)(iii) and must comply with the provisions set forth in the MLA regulation.”

Interagency Examination Procedures, 2015 Military Lending Act Amendments, page 3 (“Note: A transaction where a creditor simultaneously extends an additional cash advance beyond the purchase price of the securing personal property or motor vehicle does not fall under these exceptions.”)