Capitalization of Unpaid Interest

Dear Boards of Directors and Chief Executive Officers:

On June 24, 2021, the NCUA Board unanimously voted to lift the prohibition of capitalization of interest in connection with loan workouts and modifications from part 741, Appendix B. The rule became effective July 30, 2021, and applies to loan workouts and modifications on or after this date. The rule establishes documentation requirements to help ensure that the addition of unpaid interest to the principal balance of a loan does not hinder the borrower’s ability to repay the loan.

For borrowers experiencing financial hardship, a prudently underwritten and appropriately managed loan modification, consistent with safe and sound lending practices, is generally in the long-term best interest of both the borrower and the credit union. Modification options include lowering of loan payments or the interest rate, extending the maturity date, partial principal or interest forgiveness, and capitalization of interest. Such modifications may allow a borrower to repay the loan, which helps the borrower and the credit union avoid the costs of default and foreclosure.

The final rule continues to prohibit credit unions from financing credit union fees and commissions. Credit unions will be permitted to continue to make advances to cover third-party fees to protect loan collateral, such as force-placed insurance or property taxes. Maintaining the prohibition on the capitalization of credit union fees is an important consumer protection feature of the rule for member borrowers.

Consumer Protection Considerations

The final rule requires credit unions to adopt policies and procedures to ensure that loan modifications are in the long-term best interest of the borrowers. All documentation, including required disclosures, must be accurate, clear and conspicuous, and consistent with applicable federal and state laws and regulations. Any adverse credit reporting must be accurate and comply with the requirements of the Fair Credit Reporting Act, and, when applicable, state law.¹ As a reminder, section 4021 of the CARES Act provides credit protection during the COVID-19 pandemic. This protection requires credit unions to report loan modifications resulting from the pandemic as “current” or as the status reported before the modification. This protection is available beginning January 31, 2020, and ends 120 days after enactment or 120 days after the date the national emergency declaration for the coronavirus is terminated, whichever occurs later.

Credit Risk Considerations

NCUA regulations part 741, Appendix B, applies to all consumer and commercial loans. Credit unions should document why capitalizing interest is the best course of action when determining the terms of the modification. Further, the rule requires the credit union’s policy ensure that a credit union makes loan workout decisions based on a borrower’s renewed willingness and ability to repay the loan.

A credit union’s policy must also establish limits on the number of modifications permitted for an individual loan. If a credit union restructures an individual loan more than once a year or twice in five years, examiners will expect the documentation to reflect the borrower’s continued willingness and ability to repay the loan.

The NCUA continues to encourage credit unions to work with their members who are experiencing financial difficulties due to the COVID-19 pandemic using safe and sound approaches. Therefore, the NCUA will not object to previous loan modifications, including interest capitalization, prior to the effective date of this rule change if such efforts are conducted in a reasonable manner with proper controls and management oversight.

Please contact your NCUA district examiner, your regional office, or your state supervisory authority if you have questions.