CFPB orders halt to 'security interest' debt collection practice
Navy Federal was fined $28.5 million over credit union practice of freezing accounts
By Fred O. Williams | Published: October 25, 2016
Credit unions may seize your deposits if you default on your credit card or other loans, but the practice is coming under scrutiny after a regulatory crackdown this month.
The U.S. Consumer Financial Protection Bureau ordered changes in debt collection practices at Navy Federal Credit Union, the largest U.S. credit union, Oct. 11. It also issued the lender a $28.5 million penalty.
Among other provisions, the order penalized the credit union for freezing members' entire checking or savings account without warning, shutting off their ATM cards and blocking their access to online account services and information.
"I think if you look at the practices of other credit unions, Navy Federal would not be unique," said Donald Maurice of Maurice Wutscher, an attorney who represents financial institutions.
The credit union froze accounts of about 700,000 customers since 2013, sometimes just one to five days after a loan default, according to the CFPB order. Most account freezes happened six to 16 days after default.
The order creates new rules for lenders as they enforce their "security interest" in borrowers' checking and savings accounts. A security interest, also called a set-off or offset right, makes funds in a deposit account collateral for loans at the institution. Credit cards issued by credit unions usually contain a security interest clause. The clause makes funds in members' checking and savings accounts -- including joint accounts -- subject to seizure if the card goes into default.
The order used the Dodd-Frank Act's broad power to halt "unfair, deceptive or abusive acts" against Navy Federal's account freezes, which are not specifically barred by consumer protection law.
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Do you have a credit card with a credit union where you also keep deposit accounts? Check your card agreement for language that allows your deposits to be seized if the credit card goes into default. The agreement should be on the issuer's website, or might be found on the U.S. Consumer Financial Protection Bureau's database of card agreements. Look for phrases involving "security interest" or a "pledge" of shares or deposits.
"It is a bit of a wake-up call," said Marvin C. Umholtz, president of Umholtz Strategic Planning & Consulting Services in Olympia, Washington, a credit union industry consultant. "Credit unions do file security interests in collateral all the time. If Navy Federal can't comply with this, who can in the credit union world?"
When a loan is in default, the entire unpaid balance can be seized, not just the overdue payment, making funds unavailable for other obligations such as rent, mortgage and utility bills.
The CFPB's order does not mention Navy Fed's security interest, and the agency said through its communications department that security interests were outside the scope of the enforcement action.
However, by challenging ways that Navy Fed exerted control of delinquent members' accounts, the order sets out new guidelines for the industry, legal experts said. Credit unions are on notice not to shut off ATM cards so that members can't check their balance or use other features, and not to block access to online account information and services, such as submitting travel notices.
Credit unions may still freeze or collect the amount of the defaulted loan, without impairing access to remaining funds in deposit accounts, legal experts said. The exception is government benefit payments, such as Social Security or veterans' benefits. Government benefit payments have special protections from seizure under federal law.
Several credit unions contacted by CreditCards.com were unwilling to talk about their security interest practices. One exception was State Employees Credit Union in Raleigh, North Carolina, the second-largest credit union nationally. State Employees exercises its security interest in depositors' accounts only as a last resort when a loan is long overdue, according to Spencer Scarboro, senior vice president of lending integrity.
"We don't want to put a member in a situation where they are using a point-of-sale card, maybe they're at a gas station, and they have their access blocked," he said. If plans to repay the loan fall through, or the customer can't be reached to discuss repayment, the credit union will move to collect funds still left in checking or saving at that point, he said.
The practice of taking a security interest has its roots in the Federal Credit Union Act, the Depression-era law that sets the legal framework under which the member-owned financial institutions operate. The law gives credit unions a lien on members' "shares," the technical name for deposits. The Truth in Lending Act carved out an exception for credit cards, unless lenders obtained a statement from customers pledging their deposits as security for the balance due. Consequently, cards issued by credit unions usually do contain such a pledge in the account agreement.
"For all the consumer-friendly features that credit unions have, this is not one of them," said Joseph Ridout, consumer services manager at Consumer Action in San Francisco. "It is a big surprise when you fall behind on your loan to find that your money (in deposit accounts) has been seized to pay it."
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