You Don’t Know GAP
You Don’t Know GAP

For those who are involved in the world of F&I but were sleeping beneath a rock for the last few months, the U.S. Department of Defense issued a reinterpretation of the Military Lending Act last December. Under that new interpretation of the MLA, the exemption of automobile financing from the scope of that law is in danger.

As DoD now interprets the law, the automobile financing exemption is still in place unless the financed transaction includes “cash-out,” or … Well, before I go any farther, let’s pause on this wrinkle.

Don’t Make Personal Loans

“Cash-out” deals are those where, say, a $28,000 deal is financed for $35,000 and the customer takes home a check for $7,000. What’s wrong with such a transaction? Let me count the ways.

First, it is likely that, in order to support a $35,000 extension of credit, the value of the collateral is overstated by $7,000. That could be considered bank fraud and wire fraud.

Second, such an overfinancing probably violates the terms of the agreement — commonly (and incorrectly) called a “lender agreement” — between the dealership and the finance source that buys the retail installment sale contract (RISC). If things go sideways, you may assume the RISC becomes recourse paper and the dealership owns the deal.

Third, such an overfinancing could be characterized as a personal loan disguised as a RISC. Personal loans and RISCs are treated differently under state law. The former often requires a license, for example. Writing personal loans without a license is frowned upon.

And finally, while automotive finance should be exempt from Consumer Financial Protection Bureau oversight pursuant to the Brownback Amendment, that exemption doesn’t apply to entities offering personal loans. Backing into CFPB oversight is not something most dealerships would willingly entertain.

Bottom line: Cash-out deals are a bad idea and should be avoided. If that’s all DoD said in December, you wouldn’t be reading this article. Yet here we are.

GAP, Credit Insurance, and Covered Borrowers

DoD’s December reinterpretation also removes from the warm and friendly embrace of the automotive finance exemption deals that finance GAP or credit insurance. (To save syllables, I’ll refer to both, collectively, as “GAP.”) Because of that unfortunate fact, many dealerships are simply not selling GAP until sanity returns to the Pentagon and a more reasonable interpretation is issued. But is that enough?

Unfortunately, no. Even if a dealership avoids selling GAP to “covered borrowers,” as the MLA defines that term, the CFPB still has something to say.

Back when the automotive finance exemption covered deals with GAP, the retail automotive world didn’t worry about what the CFPB thought of the MLA. Now we do, and it turns out they have made their thoughts known.

In September of 2016, the CFPB issued “Interagency Examination Procedures” with respect to the MLA. Largely ignored at the time, they now need to be read and taken seriously. Even if a dealer elects not to sell GAP to covered borrowers, they should still take the following steps:

Step 1: Have a written MLA policy. If your dealer’s policy is to not sell GAP to covered borrowers, put that in writing. Also record the process they will follow to ensure that they don’t.

Step 2: Train employees on the MLA policy. That training can be written, online, or in-person, but be sure that you document the process and that you can prove your dealer client’s employees actually learned what was taught.

Step 3: Check all GAP and credit insurance customers for covered borrower status. You can do this through your CRAs when you pull a credit report, or by using the DoD MLA website: Whichever method you use, be sure to print and retain documentation of the result. And if the results indicate a customer is a covered borrower, don’t sell GAP to that customer.

Step 4: Establish an audit process. The CFPB has published their own audit process for MLA compliance. At the top of their checklist:

  • Existence of written policies
  • Extent and adequacy of training
  • Documentation of covered borrower status checks

Is there a way to avoid this new paperwork and procedural burden? In a word, no. Under the current interpretation of the MLA and its implementing rule, it is safer to not sell GAP to covered borrowers than to take the risks inherent in doing so. But the only way to ensure you aren’t is to confirm the status of every GAP customer. That requires a written policy, training, a process for checking covered borrower status, and a method of auditing compliance.

Unfortunately, sleeping under a rock is not a viable MLA compliance strategy.