Could someone specifically point to where i can read to better understand how PPFCs effect the APR differently than regular finance charges. I have been reading reg Z but i think i'm missing it.

It doesn't affect the APR differently. Prepaids are just that - finance charges that are paid before consummation.

http://www.occ.gov/static/publications/handbook/truth-in-lending-handbook.pdf

I use the OCC Handbook quite regularly to determine what is or is not a PPFC. Remember, only PPFC's affect the APR and they are easily defined as "costs of credit". If the customer were to pay for the house with cash, anything they would have normally incurred (government recording charges, title policies, appraisal, etc.) would be finance charges and anything above and beyond that is typically a prepaid (loan origination/administration charges, prepaid interest, prepaid mortgage insurance premiums, etc.) because they are only incurring that fee because they're being financed. Page 220 of the handbook is a fantastic resource for PPFCs. It's a tad confusing because it only states "Finance Charge", but when it says it is a finance charge, they're referring that it is a prepaid finance charge.

Hope this helps.

Page 220 of the OCC Handbook is what it states--a Finance Charge Chart. It includes numerous types of PFCs, but is not limited to PFCs. Life of loan interest and MI renewal premiums, for example, are always FCs but almost never PFCs.

All FCs, prepaid or otherwise, affect the APR.

All PFCs are FCs--the single distinguishing difference is timing of collection. Any type of FC that is collected at or before consummation of the credit contract becomes a PFC.

All FCs collected by way of the payment schedule are normal FCs, not PFCs.

Any FC netted out of a principal advance before or after consummation (example: construction inspection fee) is a PFC.



Not according to Regulation Z. When a consumer buys a home with cash, there are no FCs because the transaction is not credit and is therefore not subject to TIL. In a typical mortgage loan that is subject to Regulation Z, these charges are specifically excluded from the FC by Section 226.4(c)(7) of Regulation Z, as shown on page 220 of the OCC Manual.

Richard,

"All FCs collected by way of the payment schedule are normal FCs, not PFCs"

Would the APR be different if the FC is collected by way of the payment schedule vs prepaid?

I think one day i'll understand

Often, the easiest way to understand something is to reduce it to it's simplest form. For loans, that means a single advance and a single payment in one year. If our loan is $1,000 at a simple rate of 10%, that generates a FC of $100. Instinctively, any lender would rather collect the FC immediately (making it a PFC) instead of waiting a year to collect it. When you calculate the APRs for these two options, the difference in yield (APR) confirms the lender's instinct.

The APR formula for a single payment loan is simple arithmetic and easily solved:
FC X 100 / AF X # time units in a year / #time units in the loan term

Option 1, $100 collected at maturity
In this case, the $100 is a FC. It is not a PFC because it is not collected at or before consummation. Reg.Z defines the AF as the principal amount of the loan minus all PFCs. In this case, there are no PFCs, so the AF is $1,000.00. Our loan term is one year, so time units are a year in length. Solving the equation, you have:
APR = $100.00 X 100 / $1,000.00 X 1 / 1 = 10.000%

Option 2, $100 collected at consummation
In this case, the $100 is both a FC and PFC because it is collected at consummation. Here, the PFC is $100.00 so the AF is $900.00 ($1,000.00 - $100.00). Solving the equation, you have:
APR = $100.00 X 100 / $900.00 X 1 / 1 = 11.111%

Although the math becomes far more complex for instalment loans, the principals are the same.

Richard this was very helpful. I really appreciate you taking the time to explain this.

My final question (yeah right)is this...

I noticed when i use our internal loan calculator for a 500.00 loan, if i put the loan fee in the pre paid charges field it spikes the APR to around 92.68%. This is a 30 day loan. The fee is being collected up front by deducting from loan or customer is able to pay out of pocket, so PPFC.

Loan amount 500.00
stated rate 18%
pre paid charges 26.75 (loan fee)
The result is 473.25 amount financed
33.65 finance charges (including interest)
Total payments 533.65


Now, same 500.00 loan. If i don't put the fee in the pre paid charges field and add the fee to the loan amount the APR stays the same as the stated rate.

Loan amount 526.75 (including fees)
stated rate 18%
no entry for PPFC
result: 500.00 amount financed
APR: same as stated rate
Total finance charges: 7.27 (interest)
Total payments 534.02

I have heard that the high APR is a problem for Florida because of usury laws. I don't know. Is the usury based on stated rate or APR? I'm researching for Florida.

If this is the case (too high APR)

Would it be a feasible option to just add the fees to the loan amount? I know they will still be finance charges but could it make enough of a difference in the APR to not be in violation of usury laws?

Signed,

Determined to understand

Thanks

certainly not Richard..the ultimate Z guru! But...I believe you haven't properly calculated your second scenario. I believe your
Loan and amount financed should be $526.75 because you aren't collecting the fee upfront, thus it doesn't affect your AF.

Finance charges equal the total payment amount minus the amount financed, so in the second scenerio, the finance charge should be $34.02 and the APR calculation is wrong.

Loan amount 526.75 (including fees)
stated rate 18%
no entry for PPFC
result: 500.00 amount financed
APR: same as stated rate
Total finance charges: 7.27 (interest)
Total payments 534.02

The $26.75 is still a PPFC. A PPFC is any FC paid in cash at or before consummation or is added to or subtracted from the loan proceeds.

However, your amount financed of $500 is still correct but I'm not sure how the system arrived there if no PPFCs were entered.

Loan Amt = $526.75
PPFC = $26.75
Amt Fin = $500.00

Then how does Richards example come into play with the $100.00 fee scenario not a PPFC, but collected at maturity?

His example is showing collecting the earned interest (1000 X 10%) and it has no other loan fees.

His other example, collecting it up front gave the borrower the effective use of only $900 for the loan term thus increasing the yield on the loan for the lender.

If that were the case then, wouldn't Richards first example be a loan of $900.00? The $100 is added in over the term of the loan for a total loan of $1000.00.

The second scenario is the same $1000.00 loan with the $100.00 taken out at closing for an AF of $900.00.

so, what is the difference in that as the following:

$526.75 Loan amount at 18%

or

$526.75 less ppfc of $26.75 for AF of $500.00?

Richard's examples do not include ANY loan fees. His examples are taking a $1000 single pay loan at 10% ($100 earned interest over a year) and how collecting the earned interest either at the beginning or end of the contract affects the APR.

Collecting the earned interest as it comes due does not qualify it as a PPFC where collecting it at consummation does therefore increasing the effective yield.

OK..I guess it's the wording that's confusing.

Option 1, $100 collected at maturity
APR = $100.00 X 100 / $1,000.00 X 1 / 1 = 10.000%


Option 2, $100 collected at consummation
APR = $100.00 X 100 / $900.00 X 1 / 1 = 11.111%

RR Joker


I did make a mistake on the second example. I ran it again and here is the result

Loan amount 526.75 (including fees)
stated rate 18%
no entry for PPFC
result: 526.75 amount financed
APR: same as stated rate
Total finance charges: 7.27 (interest)
Total payments 534.02

That is still wrong. The fee is a finance charge regardless of when it is assessed, i.e., whether collected upfront or over the course of the loan. Your amount financed is $500 - that is all the money that the customer is getting.

UGH..Dan...I'm chalking this one up to long week and Friday...geez...I wasn't seeing the forest for the trees, obviously.

Thanks for not smacking me!

nbk, you're loan amount says it's including the fee...so that's the problem with your calculation.

You can lend an odd amount and give them a check for that amount and earn interst on the total of that amount...but all you'll earn is the interest over time..not a fee plus interest on the remaining AF.

Loan amount 526.75 (including fees)
stated rate 18%
no entry for PPFC
result: 526.75 amount financed
APR: same as stated rate
Total finance charges: 7.27 (interest)
Total payments 534.02

Calculations are based on a loan due 30 days from today.

Loan Amt - $526.75
Amt Fin - $500.00
Total of Payments - $534.54
APR - 84.047%

Total Charges Affecting APR - $26.75
Interest - $7.79
Total Fin Chrgs - $34.54

Paragraph 18(b)(3).

http://www.bankersonline.com/regs/226/suppi226-18.html

Wow! I go get a haircut & run a few errands and discover I've been the subject of this non-stop discussion. Let's see if I can help us focus on the issues that are causing trouble.

Dan is correct to observe that I intentionally stuck to interest in my examples. Option 1 is interest in arrears and Option 2 is interest in advance.

For 4 decades, I have tried (unsuccessfully) to crush the idea that you can "finance fees" by adding them to the loan amount. A loan is an account receivable--a debit balance on the G/L. Fees are either income or pass-through items which must be remitted to third parties. Handled either as capital (fee income) or an account payable, fees always show up with a credit balance on the G/L. You simply cannot add credits to debits and get a larger debit balance (loan amount.) "Financing fees" is banker jargon which has lead to endless confusion when you have to get to the bottom of what is happening and paste TIL labels on the dollar amounts.

There's an intermediate step that's being overlooked. In double entry accounting, there's always an offsetting entry. When NBK declares that her customer owes the bank a loan origination fee of $26.75, she knows that the fee will be credited to some kind of fee income account and that's the end of the fee. So.....what's her offsetting debit for $26.75?

Cash? Yes, if the customer pulls out his/her wallet and pays the fee on the spot, NBK will debit cash. This is very unusual, but it happens.

Deposits? This probably happens a bit more often than cash, but a $26.75 check would pay the fee by debiting the borrower's deposit account.

Loans? By far, the easiest way to collect the loan fee is to earmark some of the loan proceeds. Here, the lender has two choices. The simpler method is to offset the $500.00 debit to loans with a $26.75 credit to income and a $473.25 credit to official checks. The not-quite-as-simple method enters the picture when the borrower balks at the reduction in proceeds. (Example: borrower's brother is in jail and bail is $500.) Since the fee will be taken from loan proceeds, but the net proceeds must equal the applicant's original request, the lender simply grosses up the note. You may skip the formality of amending the loan application to an amount of $526.75, but that's what's happening--the borrow has increased the requested loan amount. Now, you will debit loans for $500 and credit official checks for $500 and then debit loans again for $26.75 and credit fee income $26.75.

After determining the amount of the loan fee and how to collect that amount, you have a principal loan amount of either $500 or $526.75. Using the agreed amount, your interest rate and term, you calculate the payment schedule.

Notice that I haven't said a single word about Regulation Z disclosures up to this point! So far, all we've done is figure out what entries are necessary to book a new loan and collect a loan origination fee.

Loan origination fees are always FCs. In all cases discussed above, you put the $26.75 loan origination fee into your G/L account for fee income on the date the loan was consummated. That makes the $26.75 a PFC.

Reg. Z defines the AF as the principal loan amount minus the PFC. In the brother-in-jail scenario, your principal amount is $526.75. In all other cases it is $500. Therefore, the AF is $500 for the brother-in-jail borrower and $473.25 for the other cases.

The disclosable payment schedule is whatever you calculated and wrote into the note.

The TOP is the sum of all the disclosed payments.

The FC is the difference between the TOP and AF.

Feed the AF, payment schedule, and dates into APRWIN or any other APR calculator and you will get a correct APR for each case discussed above.

And that's why he's the expert.

When the origination fee is paid in cash it reduces the loan amount and the amount financed and finance charge is less. Why would the APR go UP when the fee is paid in cash? I double checked the calculations on APR Win and all is ok there. I'm having an off day and I should know this but it's escaping me right now.

Example: OF paid in cash
Loan Amount = $10,251.85
AF = $10,026.85
TOP = $11,285.90
APR = 8.0277

OF Financed
Loan Amount = $10,476.85
AF = $10,251.85
TOP = $11.533.60
APR = 7.9942

Thank you!

Think orange paint.

You begin with a can of red, a can of yellow, and an empty can for the product. Pour in a generous amount of red. Then, add yellow. Orange, right? Now add more red. Not quite as orange, right?

When you started building this loan, you took an interest rate and generated a payment schedule. At this point, you only have interest in the "can" and the APR's equal to the IR right? Then, you added a fee. After blending the two "colors", the APR's no longer equal to the IR--it went up (it's orange!) Now a little more interest (because the principal amount increased when you "financed the fee"), but no more fee. Not quite as orange anymore, right?