"An Act relating to the handling of negative equity in motor vehicle transactions; and relating to the contents of retail installment contracts. "
"So the bottom line is that while Federal law has been revised to accommodate this situation, our state law has not. SB 300 resolves this disparity ..."
- Sen. Seekins
Senate Bill 300 updates the definition of "principal balance" found in the Alaska Retail Installment Sales Act to accommodate the proper disclosure of negative equity. Furthermore, the bill clarifies how, within a lease arrangement, an incidence of negative equity is handled.
There was a time when lending institutions required borrowers to monetarily participate in purchase transactions. In fact, down payments of 25% were quite common. Furthermore, term loans were held to a maximum of 36 months. But, over the last several years these guidelines have gone by the wayside. The strength and stability of the national economy have spurred consumers to demand lower-payment loans along with greater value.
Banks, credit unions and acceptance companies have accommodated the marketplace by offering low, or no, down payment options as well as lengthening the allowable repayment period for many types of lending products. This phenomenon is particularly evident in retail auto sales where qualified buyers often broaden their budget by opting for 100% financing over the longest possible term.
The mathematical effect of this financing strategy is simple - the point in time at which the vehicle's market value exceeds the outstanding balance on the underlying loan occurs much later than it otherwise would. Until this point is reached, the owner's equity position is commonly known as "upside down" or "negative". In other words, the value of the vehicle is not yet sufficient to completely repay the outstanding balance on the loan.
As a result, when the owner wants to trade for a different vehicle, the dealer has to figure out some way to accommodate the loan payoff in the trade-in. At one time it was common practice in some states to simply inflate the price of the car to be purchased enough to permit an allowance for the trade-in that would cover the amount owed. The negative equity disappears.
This method solved the equity problem but failed to adequately describe the transaction mathematically. So, over time, this practice fell into disfavor and, today, it is more common that new vehicles are sold at non-negotiable prices, i.e., through factory incentive programs. Furthermore, the Federal Reserve Board provided guidance on this issue through revisions made to Regulations M and Z. These Regs control the manner in which lease and credit transactions (respectively) are disclosed.
Reg M was revised to provide a dedicated disclosure line on the lease agreement in cases where a prior loan or lease balance (negative equity) is rolled in to the new lease transaction. Revisions made to Reg Z altered the definition of "down payment" thereby solving the negative equity issue as it may pertain to a loan transaction.
So what does all this have to do with Senate Bill 300? The vast majority of banks and credit unions are federally regulated. Therefore, they follow federal disclosure laws (state laws do not come into play). However, acceptance companies, like GMAC, Ford Motor Credit, and others, are required to follow federal and state laws. The dual adherence requirement has effectively created a disparity in the manner in which loan and lease transactions are disclosed in cases involving negative equity here in Alaska.
So the bottom line is that while Federal law has been revised to accommodate this situation, our state law has not. SB 300 resolves this disparity by updating the definition of "principal balance" as it pertains to the state's disclosure requirements for retail sales contracts found in Chapter 10, Title 45. Furthermore, the Bill adds corresponding language to Chapter 25 pertaining to the handling of negative equity with respect to lease agreements. These modifications bring state and federal law back into alignment.