Lines of Credit and Terminated Memberships Posted by AVCU on 8:43 AM

 No credit union likes to see its members leave the credit union or to have to expel someone from membership. However, when a membership is terminated, certain processes and procedures kick in. For example, determining how to close accounts, refund any balance in those accounts and shutting off any debit cards. But what happens to outstanding loan balances?

Under the Federal Credit Union Act, federal credit unions are prohibited from lending to nonmembers. For closed-end credit, this is rather straightforward – the borrower must be a member at the time of consummation. As long as this requirement is met, terminating a membership during the lending relationship does not have a huge impact on the loan. The loan agreement remains in place and the borrower is still obligated to pay back any outstanding balance regardless of their membership status.

However, when it comes to open-end credit, such as a line of credit, HELOC or credit card, the analysis gets a bit more challenging. This is because credit is extended each time a new transaction is made. The effect of this is that the borrower must be a member at the time each new transaction is made. When a membership is terminated, any subsequent transaction on an open-end credit account would be considered lending to a non-member. So, what happens when a borrower ceases to be a member, yet still has available credit on his account?

In Legal Opinion Letter 00-0133, NCUA addressed the issue of new credit card transactions after a membership has been terminated. In the letter, NCUA explains once membership has been terminated, no additional extensions of credit are permitted. However, the former member is still obligated to repay the outstanding balance according to the terms in the account agreement. In practice, this could mean a credit limit is restricted or the account is closed to new purchases when membership is terminated. The issue then becomes what type of notice, if any, is required under Regulation Z. Though keep in mind an adverse action notice may not be required, as discussed in this NAFCU Compliance Blog post.  

Section 1026.9(c) generally requires either 15-day (HELOCs) or 45-day (other types of open-end credit) advance notice of certain changes to the account. However, both section 1026.9(c)(1)(iii) and 1026.9(c)(2)(vi) provide a special rule when decreasing a credit limit. For HELOCs, the notice of a decrease in a credit limit must be provided within three business days of taking such action and note the reason for the action. For other open-end credit accounts, 45-day advance notice is required before a credit union may impose an over-the-limit fee or penalty rate solely for exceeding the newly decreased limit. The notice may be provided orally or in writing and state that the credit limit has been or will be decreased. The preamble to the 2009 final rule that added this provision explains that the decreased credit limit may take effect immediately, but credit unions must wait until 45 days after notice to impose the fee or rate. The preamble goes on to explain that simply showing the decreased credit limit on a periodic statement is not sufficient to meet the notice requirement. The disclosure on the statement must also indicate that the credit limit has been or will be decreased.

When a membership is terminated, either voluntarily or through expulsion, ensuring compliance with the Federal Credit Union Act’s prohibition on lending to nonmembers can easily get overlooked when it comes to open-end credit plans. Federal credit unions may want to verify they have procedures in place to comply with the Act and ensure that proper notice is provided before imposing any fees or penalty rates after decreasing the credit limit. State-chartered credit unions may want to review applicable state law to determine whether similar rules apply.