The moment your borrower drives their new car off the lot, it’s worth less. Sometimes, a lot less. For this scenario, your financial institution knows to offer GAP coverage as protection. What about safeguarding against other risks?
You’re thinking Debt Cancellation or Suspension Contracts, of which GAP is a cousin. These serve to protect the value of a car or suspend debt in the event of major life challenges. They all fall under the umbrella of Payment Protection.
Debt cancellation products are valuable add-ons for protecting your institution and borrowers. This article will review the benefits and advantages of Debt Cancellation Contracts (DCC) and Debt Suspension Agreements (DSA).
If you’re wondering how this would help people who have spent a year struggling through COVID challenges…yes, it’s exactly what they want. Protect them while ensuring your institution doesn’t lose, either.
We want you to be well-informed to make the right decision for your credit union or bank. Towards that goal, we will also dive into potential risks of adding DCC or DSA terms to your loan products.
Disclosure: Our firm, GreenProfit Solutions, Inc. offers debt cancelation products. However, what we have may not be a fit for your institution. That’s cool. We want to ensure you have all the information necessary to evaluate and make the right decision for your institution and borrowers.
Sound good? Let’s go!
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Debt Cancellation Contract
Debt Cancellation Contracts do just what they say on the label. They cancel outstanding debt owed by a borrower to the institution, if certain life events occur. It is a contract between the lender and borrower.
What type of life events may apply? This is a non-exhaustive list of examples:
- Death of the Borrower
- Death of a Breadwinner
- Major illness, Accident, or Disability
- Involuntary Unemployment (UIU)
- Marriage and Divorce
- Maternity and Paternity Leave
- Military Service
Debt Suspension Agreement
Full debt cancellation may not be your only goal. What if you want to allow a borrower to suspend their payments, but not abandon the debt entirely? There’s a product for that, too.
Called a Debt Suspension Agreement, this will:
- Suspend payments,
- Parts of the debt, or
- A combination of some or all of the above.
This lets your institution provide borrowers with flexible options in the event of financial difficulty triggered by a specific covered life event.
Benefits of Debt Cancellation
Debt cancellation provides multiple benefits to both borrowers and lenders, including protections normally associated with insurance policies. Yet here, there’s some positive news.
Federal regulations do not classify debt cancellation products as insurance, since they are offered by the lending institution for their own products. The Office of the Comptroller of the Currency oversees regulations in all national banks and institutions.
Benefits for Financial Institutions
Your financial institution can look forward to offering an ancillary product for your lending without some of the typical challenges. Licensing is generally simple and non-interest income is available.
In most jurisdictions, DCC and DSA are not considered insurance. Therefore, there are no licensing requirements. Just make sure if you’re a state-chartered institution.
Any product added to a loan adds the opportunity for revenue. One choice tends to have the largest role in determining the potential income: How you’ll insure it. You’ve got two options:
- Self-insured: Your institution sets the rates and keeps 100% of the price charged to the borrower (this may vary for state-chartered institutions in some states). Of course, you’re responsible for paying out when necessary.
- Insured: Purchase a Contractual Liability Insurance Policy (CLP). Your institution includes the cost into the retail price charged to your borrowers. Upsides: You’re not responsible for paying out claims and there’s a possibility to participate in a profit-share arrangement.
Cross State Line Parity
Does your institution have branches in various states? Unlike insurance, you can have the same plans and rates regardless of which state you are doing business.Talk about simplifying the offering!
Reduced Debt Collection Costs
This is the crux of why you offer these products. The events covered can have major disruptions in your borrower’s finances. Sometimes, the challenges can drive your borrower and their family into bankruptcy.
You can help avoid such a situation, while ensuring you receive the full value of your loan.
- Reduces the overhead of debt collection and;
- Increases the per-borrower profitability of a loan.
Medical issues, divorce, job loss, and more and can cause borrowers to ghost a loan. In a post-coronavirus world, risks are even higher. These are truths from prior to the pandemic:
- 78% of American workers are living paycheck to paycheck
- Nearly 3 in 10 people have no “emergency fund”
Do you think it’s going to get better or worse? Debt Cancellation products help reduce risk to your financial institution from borrower defaults.
Benefits for the Borrower
Peace of Mind
Debt is stressful. It’s even worse if you’re in the midst of a life crisis. Debt cancellation can relieve that stress and provide peace of mind. Debt suspension allows time to reorganize finances if that’s chosen as well.
Avoids Negative Impact on Credit
One bad debt creates a spiral of challenges for years to come, mainly through impacts to a borrower’s credit. Debt cancellation protects their credit score against the risks of life.
A DSA or DCC can be charged in one of two ways: A one-time payment at loan closing, or, more often, on a Monthly Outstanding Balance (MOB) basis, rolled into the loan repayment terms. This allows the borrower to spread the costs over many months.
Unlike insurance, which may require medical records or exams, DCC and DSA are issued based simply on the outstanding balance. Note: There might be waiting periods. Check with your vendor to learn applicable terms.
Think DCCs and DSAs come in one form? Not quite! As the provider, you may choose a range of cancellation plans. This gives your borrowers more options to customize a repayment agreement that best matches their risk profile, budget, and need for funds.
Potential Risks…Or, What You Need to Know
Before offering Debt Cancellation or Suspension Products, take note of these points.
For State-Chartered Institutions
The regulations regarding debt cancellation are clear for national banks and institutions. It’s not insurance. No licensing needed.
But what about state-chartered institutions?
Most state insurance departments recognize parity with federal regulations. Therefore, they classify debt cancellation as a banking product, not insurance, and do not regulate it…unless specifically covered by state statute.
Also linked earlier, you may read (or pass along to your in-house counsel) the relevant federal rules under the Office of the Comptroller from Cornell University Law Library.
Check Your State Insurance Laws, Bureaucratic Rulings, and Case Laws
Unless preempted by Federal or other state laws, states may regulate cancellation and suspension products as insurance, even if other states and the national government do not. This is according to a finding by the New York Department of Financial Services.
Before creating or offering any new product for your institution, it’s wise to discuss it with your legal and accounting experts. Be sure you understand any and all financial and legal requirements to offer.
You may speak with a vendor or contact your local state insurance department directly.
Debt Cancellation Product Disclosures
Like all financial products, disclosures are an important part of compliance and offering the best service to your borrowers.
DCC and DSA are regulated as financial products, not insurance products (excluding certain state rules from above). Fair Debt Collection provides a basic overview for disclosures and other borrower protections required before you offer a cancellation product.
Beyond general financial product disclosure laws, check with your state department of insurance to determine whether your state has extra rules for cancellation products. Also ask about disclosure requirements, if any, you have to perform.
Protecting Borrowers and Institution
Debt cancellation and suspension products can be important tools to help avoid risk due to life events. They protect both your institution and borrowers, while maximizing your non-interest income and revenue streams.
Is Debt Cancellation a fit for your institution? It’s definitely worth a chat. If you’d like that discussion to be with us, we’re here to make it easy. Just choose a time to have a 15 minute chat.
Want to talk more? We’ll figure it out then. Decide it’s not for you? That’s cool, too.
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