We would like to change the order of payment application and pay late charges first on all loans, including consumer. I find nothing that prohibits us from collecting late charges first, although I understand that we cannot then assess a late charge on a subsequent payment that is "short" because we paid late charges first.

From what I have read, disclosure about the allocation of payments is not required. Not all of our agreements reflect an order of payments while some do (with late charges being last.)

My question: If our agreement states a payment application order (interest/principal/other fees/late charges) must we then do a Change in Terms Agreement to change that order? Reg Z - Section 226.9(c)(2) says that no change in terms is required if a change involves late payment charges. So, am I correct that we can make this change without a formal Change in Terms Agreement? As a courtesy, send a letter to the customer?

Thank you.

You are right to be concerned with Reg AA - specifically, §227.15 concerning pyramiding of late charge.

§226.9 only applies to open-end loans. Yes, I believe you can technically make this change on your outstanding open-end loans but I definitely agree you should notify affected customers.

You cannot change any of the terms of your existing closed-end loans.

If you at a Federal Savings Association you should also look at 12 CFR 560.33 governing what those institutions can do with regard to late charges.

If you are a state-chartered bank, you may wish to look to your state laws. The states we operate in dictate the order that we may apply payments received.

This is something that you want to look at closely. There are issues regarding paying late payments first thereby not decreasing principal, which in turn causes the loan to accrue more interest.

Thank you all for the replies. In regards to changing terms on closed-end credit, would changes be permissible only with a formal Change in Terms Agreement? Okie - I've shared your concern - can you point me in the direction for doing further research into the issues of not decreasing principal?

You have to abide by the terms of the contract. In most cases these contracts (closed-end) cannot be unilaterally changed, therefore your borrower would have to agree to the change by signing a change in terms agreement. And if they refuse you have to honor the existing contract. I for one would not agree to such a change in my contract.

Also, one thing I don't see mentioned. The late charge will leave the payment short. What will be your policy for advancing the payment date. I pay my Nov payment 12 days late, you hold out a $17 late charge. Do you advance my payment to Dec since it is now $17 short? And what do you do if I make my payment on time in Dec for the payment amount since the previous payment was $17.00 short? Also, as Okie Banker suggests, this will cause the account to accrue additional finance charges on the unpaid $17. I would argue in court, and probably win, that you are charging interest on the late charge and you therefore are compounding the late charge.

You are opening a whole can of worms on the closed-end credits. You better insure that you have the full blessing of the bank's attorney.

Thank you!

As Dan says above - you cannot consider the payment late (when you apply late fees first) if the balance of the payment amount due or unpaid for that month is equal to the amount of the late fee. See Regulation AA - Sec. 227.15 Unfair late charges:

(a) In connection with collecting a debt arising out of an extension of credit to a consumer, it is an unfair act or practice for a bank to levy or collect any delinquency charge on a payment, when the only delinquency is attributable to late fees or delinquency charges assessed on earlier installments, and the payment is otherwise a full payment for the applicable period and is paid on its due date or within an applicable grace period.

(b) For the purposes of this section, collecting a debt means any activity, other than the use of judicial process, that is intended to bring about or does bring about repayment of all or part of money due (or alleged to be due) from a consumer.