We have a consumer that has made payments that have advanced the due date greater than 4 months, and is now taking a break from payments. I have been asked if we are required to send them a letter letting them know that the interest due on their loan is now greater than their regular payment amount.

I have not been able to find any source that states we are required to do it, but that it is more of a best practice. Can someone please confirm it is only a best practice or lead me to the source if it is a requirement.

Other helpful facts:
1) Not a mortgage loan
2) State of Texas FI

Thank you in advance for assistance!

If you have your loans set up on a scheduled payment basis on a non-mortgage loan that is very unusual. If you do, then you apply the payment as of the payment due date. If these are simple interest loans, you cannot pay a simple interest loan ahead. Any additional payments go to principal, and it does not move the payment due date.

I suspect you have a confused customer and a serious loan servicing problem.

Notifying the consumer that they prepaid their loan, but are losing the potential savings by taking a break is a good idea. They may not realize that. Also, I have on occasion told a borrower that prepaying their loan was allowed, but contractually they were required to pay each month. Some loan systems take prepayments and advance the due date while others I have seen applied the overage to principal and next month's payment was still required to be made. That was actually when we had precomputed and simple interest accruals though.

Generally ensuring they understand the process is enough but I did have one customer who was going to be away (pre-internet banking days for the young bankers) from home for about 3 months and intended to prepay now and then pick up when they got back. In that case we were fine with it. I also had a customer who as it turned out was prepaying but was on auto-transfer. We'd programed the amount wrong but he didn't balance his account and didn't need to as he always had sufficient funds - until we screwed up. Instead of entering the payment amount they keyed in the loan date. As a result he was paying the loan really fast.

So what's your system and policy, can they prepay and advance a due date or do they need to pay monthly (or whatever period was opted for)? And communicate with the consumer. I'm aware of no reg that requires any notice, however.

Just remember - your policy is one thing, but your legal contract with the borrower governs all. Without reading your promissory notes - everything is a guess - get your legal counsel involved.

Sooo... what's going to happen when you receive the next full payment? With more accrued interest than payment, will your loan servicing system pay the interest by negative amortization? Is that legal and consistent with the terms of the promissory note?

I concur with Randy's advice to involve legal counsel, but suggest you take this one step further. Using this case and counsel's opinion re proper handling, add (or expand) this topic to your loan servicing policy and procedures. If other prepayment situations also happen from time to time, take the time now and write it all into procedures--that way, there will be no guessing (or costly mistakes) in the future.