For decades, point-of-sale (POS) financing has been a common option for large consumer sales, including for appliances, furniture, and automobiles. In recent years, ecommerce, the availability of credit through alternative models, and perceived millennial aversion to traditional revolving credit cards have all contributed to a significant increase in various forms of POS financing. In addition, partnerships with fintech companies have allowed merchants to offer a user experience where application, approval, and funding can occur within seconds at the point of sale.
For merchants seeking to expand their customer base, the advantages of offering POS financing are enticing. POS financing helps reduce consumer sticker shock by breaking an otherwise big-ticket purchase, like a mattress, smartphone, or sofa, into more manageable installments, and the credit approval and execution of the sale can occur within seconds at a retail location or online.
Despite the many benefits, as a form of consumer credit, POS financing is a regulated financial services activity that may create compliance requirements for both the merchant and any finance company with which they partner. In this series, we will explore the regulatory considerations applicable to various POS financing models, starting with a "credit seller" or retail installment sales agreement (RISA) model.
What is a RISA Model?
Under a RISA model, the merchant makes a sale on credit by permitting a consumer to purchase goods or services and repay the cost over time in installments. As discussed below, the merchant may choose to retain the contract (and the credit risk) or may choose to sell and assign it to a sales finance company. Where the credit sale contract meets the definition of a RISA under state laws, the merchant will be subject to certain disclosure requirements and may be required to apply for a license or registration.
Nearly every state has a RISA statute, and, while definitions may vary between states, a RISA is typically defined to mean a contract for the sale of goods or services in which:
- The buyer is a natural person;
- The company granting credit regularly engages as a seller in credit transactions of the same kind;
- The goods or services are purchased primarily for personal, family, or household purposes;
- The amount of credit extended is below a particular dollar threshold (e.g., $25,000); and
- A finance charge is imposed on the buyer or the debt is repaid in installments.
A "finance charge" means any charge payable directly or indirectly by the buyer as a condition of the extension of credit, and includes interest and certain other fees. Even where the transaction does not include interest or finance charges, a credit sale is a RISA in most states if the buyer may repay the purchase price in two or more installments. RISA statutes may also regulate credit sales through revolving credit accounts. In addition, RISAs for motor vehicle sales may be regulated under separate statutes with no dollar cap.
What Compliance Requirements Apply?
When a merchant decides to offer a POS financing program through RISAs, it is acting as a creditor and is subject to certain consumer financial protection laws and requirements. Among others, these may include:
- Truth in Lending Act / Regulation Z: The Truth in Lending Act (TILA), and its implementing rules under Regulation Z, apply to extensions of consumer credit that are subject to a finance charge or payable in more than four installments. Among other requirements, TILA requires creditors to provide specific disclosures about the annual percentage rate (APR), finance charge, amount financed, total of payments, payment schedule, and other terms and conditions of the RISA.
- RISA Content Requirements: In addition to TILA, state RISA laws also impose requirements on the content, terms, and disclosures set forth in the RISA contract. These include requirements with regard to the title of the document, the font size, itemization of the amount financed, and specific "Notice to Buyer" disclosures that must be stated in the contract. Failure to include these items may, in some states, result in the forfeiture of any interest or finance charge collected or affect the enforceability of all or part of the RISA.
- Licenses and Registrations: More than a dozen states have a notification, registration, or license requirement for merchants that sell goods or services on credit if the transaction meets the definition of a RISA in that state. Some notice or registration requirements may be satisfied through a brief submission with basic information on the applicant, but a small number of states have a full license requirement. Among other requirements, a license application includes information on the company and its officers, directors, and primary owners; financial statements; surety bonds; and a business plan. State financial regulators have broad statutory authority to punish unlicensed or unregistered activity by issuing cease and desist orders, imposing civil monetary penalties, and requiring forfeiture of any interest or finance charges collected under RISAs.
Working with Sales Finance Companies
In most RISA models, the merchant that makes the initial sale on credit through a RISA does not retain the account. Often, the merchant will sell and assign the RISA to a third-party "sales finance company" soon (or immediately) after closing the transaction with the consumer. Working with a sales finance company is a common model and has existed, for example, in the indirect auto credit industry for a long time. Such partnerships allow the merchant to move credit risk off its books, provide a source of funding for RISAs, and may give the merchant access to underwriting and pricing guidance from the sales finance company.
Although working with a sales finance company provides a number of benefits for a RISA model, merchants should be aware that the inclusion of a partner presents additional issues, including the following:
- RISA Documents: Because sales finance companies often work with multiple credit sellers, they may provide their own RISA contract documents. Merchants should carefully review these documents to ensure they comply with TILA, state RISA law requirements, and any other disclosure requirements. Regardless of whether the merchant retains the contract, the original creditor may be held liable for using noncompliant documents in its transactions.
- Sales Finance Licensing: Sales Finance Companies are typically more heavily regulated than merchants that sell on credit through a RISA. More than twenty states require a company to obtain a sales finance license to purchase and take assignment of RISA contracts. A credit seller that sells or assigns RISAs to an unlicensed sales finance company or other third party may be exposing itself to liability. Merchants in this position should, at a minimum, include appropriate provisions in their contracts requiring the sales finance company to (1) represent compliance with TILA and state RISA and sales finance laws; and (2) indemnify the merchant for any liability arising from use of RISA contracts provided by the sales finance company or from the sales finance company's noncompliance with laws.
- Reputational Risk: Once a RISA is sold and assigned to a sales finance company, the credit seller's customer will have a direct relationship with the sales finance company. In addition to protecting itself from risk by contract, the credit seller should also consider the reputational risk of transferring its customers to a noncompliant third party. If the third party engages in unfair or abusive collection practices, this may damage the merchant's reputation and reduce potential repeat sales.
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POS financing is an increasingly popular and common method of instantly selling goods and services to consumers in an era where speed and convenience are essential to the consumer retail experience. However, before jumping on the bandwagon, merchants pursuing a RISA model should do their due diligence in ensuring that they comply with TILA and state RISA laws and confirming that third-party transferees are appropriately licensed and reputable.
Stay tuned for Part II of this series, which will discuss installment loan arrangements in which the merchant's partner finance company makes a direct loan to the customer to finance the purchase of goods or services from the merchant.