Regulation Z says that Late payment charges do not include: The continued accrual of simple interest at the contract rate after the payment due date. I am working on a lending software package and I have a question about this late payment interest.

Example:
Closed-end loan
Payment Period: Monthly
grace period 10 days
Payment Due: 01-01-01
Payment Paid: 01-12-01

Would most lenders charge the regular interest due on the payment plus 11 days of extra "late" interest at the current interest rate of the loan? If they have a late payment fee, say a set percentage of the loan payment, would most lenders still charge the extra "late" interest too?

Some of these variables are influenced by state laws. You may be precluded from charging a late fee (say 5% of the P&I payment due) plus interest on the existing balance. The interest per diem may have to be reduced based on the scheduled balance if you impose another fee.

Reg. Z says that the finance charge is based on a specific amortization. If the consumer continues to pay late, and either pays a late fee or the higher per diem than was calculated in the amortization and disclosed in the resulting finance charge, than that can't be used against the bank to say the APR and disclosures were incorrect.

------------------
Andy Zavoina
Opinions stated are not necessarily that of my employer.

Andy has it right. The disclosure is based on the legal obligation and what is known at the time of closing. You are free to assume (in fact, you should assume) that the borrower will pay on time, as per contract. Thus, actual late fees and interest for late payments does not affect the APR calculated at closing.

However, if you do charge interest this way, I would watch the practice closely. This kind of practice could get rolled onto the predatory lending snowball and suddenly turn into a public relations problem.

The answer to your question, Toni, depends on the servicing method you are reviewing. Monthly simple interest (like mortgages) works one way and daily simple interest (like many consumer loans) is different.

Mortgage lenders/servicers almost always charge monthly simple interest--current month's interest equals the outstanding principal balance times the annual simple interest rate divided by 12. All months are considered to be the same time period--1/12 of a year. Following this method, you will charge interest for the full month and add a late charge (penalty) if payment is more than # days late. (# may be determined by state law, VA/FHA standards, or other external authorities.)

Most consumer lenders switched from add-on interest to daily simple interest by the mid-1990s. Reasons included the desire to offer variable rate products and pressure at both the state and national levels to eliminate the "Rule of 78" rebate method that accompanied the add-on accounting system. After making the change, they discovered that the year had not gained any days! Although the consumer may be late this month and run up a bill for 10 extra days (40 day's interest deducted from the payment received), if next month's payment is made on time, the bank only deducts 20 days' interest from the payment received. State law may also allow the late payment penalty.

Reviving this very old thread!

We are reviewing our current system specs and it currently is set to split the payment to billed interest instead of current interest.

The discussion is that we are losing interest income by not applying the current interest balance.

Thoughts?

How are you losing interest? What type of loan are you referring too? The payment application is based on the legal agreement, it is not something you can change on an existing closed-end loan.

We are concentrating on consumer closed end loans such as a simple car loan. Our legal document says that payments will be applied at the discretion of the bank so we don’t have much direction there.


As an example, a loan with a $10,000 principal balance and a 5% rate and a $500 payment, I compute an initial per diem of $1.37.
When the loan bills, it projects that the interest balance will be $42.47.

Our sample customer pays 10 days late and has an interest balance of $56.16.
By splitting the payment to $42.47 in billed interest, more of their payment is reducing principal at that time than splitting to current interest.

Presuming that the customer then makes their second payment on time, the total interest for the two months collected is $83.62.
If we instead split the payment to the current interest, I’m calculating that they paid $83.65. Its not a large amount in the example, but the amount of principal reduction will perpetuate through to payoff and would add up over time and volume.


In an overly simplified example where a customer is 100 days past due (and using just 30 day months for simplicity)
Lets say that the payments fall out like this:
Payment 1 $500 total $300 interest $200 Prin
Payment 2 $500 total $300 interest $200 Prin
Payment 3 $500 total $300 interest $200 Prin
Per diem $10
Total interest due $300X3payments + $10X10days = $1,000

If the customer were to pay us $1,000 today, splitting to billed interest would pay $900 interest and $100 principal. Subsequent interest will be calculated at a reduced per diem.
Splitting to current interest would have it all go to interest and no principal. Our per diem is still $10.

Customers paying ahead of schedule still have payments split to billed interest so their interest balance becomes negative.

On comparable loans, we are making a presumption that more customers pay few days late than a few days early. This may not be valid basis for saying that we are losing potential income.

You have standard consumer loans booked using scheduled payments rather than simple interest?? That is really unusual and would not even be legal in some states. If you have notes that say payments can be applied at the lender's discretion, then I think you have a huge UDAAP issue and need new legal counsel.

ughhhh!

As always thank you.