Consumer Credit Transactions

1
Assurant Continuing Education

• Consumer Credit Transactions

2
Consumer Credit Transactions

• Overview of Carleton Financial Computations
• 43 Years of Experience providing credit math
  solutions
• In todays market primarily a software company
• Clients include Banks, Finance Companies, Auto
  Dealers/Financiers, Credit Insurance Companies,
  System Providers (Partners)
• The breadth of our client base allow us to see
  the Universe of computations, approaches,
  policies, and choices made by creditors.

3
Consumer Credit Transactions

• Carleton served as a member of the Federal
  Reserve Board Industry Advisory Panel during
  the creation of the Truth-in-Lending Act in 1968
  and again with the Simplification process 10
  years later.
• Carleton got a head start on the complexities
  of computing the new required value APR

4
Consumer Credit Transactions

• Because the consumer credit math is so
  specialized, much of it is open to interpretation
  by the user. To think there is a universal
  formula that everybody uses is a simplistic
  and inaccurate view of the landscape.
• Embrace the concept that calculations are
  different rather than instantly wrong if the
  resulting numbers are not identical.

5
Consumer Credit Transactions

• Communication is vital to understanding the
  principles and concepts of Consumer Credit Math
• Use and Misuse of labels adds a layer of
  confusion atop an already complex subject.
• For instance, the terms
• APR
• Principal
• Service Charge
• Actuarial Method

6
Consumer Credit Transactions

• CONSUMER CREDIT
• Credit dispersed for personal or household
  consumption. As opposed to Commercial Credit
  which is B2B.
• Loans vs. Sales
• Closed End Credit fixed duration/ number of
  payments.

7
Consumer Credit Transactions

• Four Principle Elements of a Credit Transaction
• Amount
• Rate
• Term / No. Pmts
• Payment
• Generally, if you know 3 of these elements, you
  can solve for the 4th.

8
Consumer Credit Transactions

• To fully understand a consumer credit
  transaction, you need to understand the concept
  of
• Amortization
• the gradual reduction of a debt by means of
  equal periodic payments sufficient to meet
  current interest and liquidate the debt at
  maturity.
• Dictionary of Banking and Finance

9
Consumer Credit Transactions

• The process of amortization is illustrated by a
  schedule of payments that shows the allocation of
  each payment to interest and principal.
• Theoretically speaking, the principal balance
  should be 0.00 after the final scheduled payment
  has been made at maturity.

10
Consumer Credit Transactions

• Amortization Schedules can be devised to follow
  various concepts, so the key to understanding all
  the numbers on the page are what are the rules?
• Does interest accrue
• Actuarial/Simple Interest
• Rule of 78ths
• Pro-rata

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Consumer Credit Transactions

• One Formula to Rule Them All
• I P x R x T
• Interest Principal x Rate x Time

12
Consumer Credit Transactions

• The key is clear communication and understanding
  of
• P What is included in the principal amount?
• R What type of rate is it?
• T Time The critical wildcard in the equation

13
Consumer Credit Transactions

• 1,000 Loan
• 10
• Begin Bal. Int. Prin. End Bal.
• 1,000.00 8.33 79.58 920.42
• 920.42 7.67 80.24 840.18
• Payment 87.91
• Rate 10 simple annually
• 12 Monthly Payments

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Consumer Credit Transactions

• Begin Bal. Int. Prin. End Bal.
• 1,000.00 8.33 79.58 920.42
• 920.42 7.67 80.24 840.18
• I P x R x T
• Interest 1,000 x .10 x 1/12 8.3333

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Consumer Credit Transactions
Amortization Process

• Principal Rate Term
• 1,000.00 10 12  
• Beginning Payment
  Interest Principal Ending
• Balance Balance
• 920.42 87.91 7.67 80.24 840.18
  
• 840.18 87.91 7.00 80.91 759.27
• 759.27 87.91 6.33 81.58 677.69
• 677.69 87.91 5.65 82.26 595.43
• 595.43 87.91 4.96 82.95 512.48
• 512.48 87.91 4.27 83.64 428.84
• 428.84 87.91 3.57 84.34 344.50
• 344.50 87.91 2.87 85.04 259.46
• 259.46 87.91 2.16 85.75 173.71
• 173.71 87.91 1.45 86.46 87.25
• 87.25 87.91 0.73 87.18 0.07

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Consumer Credit Transactions

• The full precision amortizing payment for this
  data is
• 87.91588723
• This value represents the Math involved in
  computing the present value to find the payment
  amount.

17
Consumer Credit Transactions

• The actual transaction charge is 54.92
• A real world adjustment must be made to
  account for the .07 difference.
• The mathematically amortizing payment for this
  data is 87.91588723. However, that amount
  cannot be physically collected.
• The payment here is truncated to 87.91.
• The mills of .00588723 are truncated off the
  full precision payment.
• .00588723 x 12 .07064676

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Consumer Credit Transactions

• The rounding of the monthly payment has a
  profound effect on the return/yield/APR of the
  transaction.
•  
• If the payment is truncated (low rounded) to
  87.91, the APR is 9.9873415
• If the payment is high rounded to 87.92, the APR
  is 10.0088428
• If the Max APR is 10, does the 87.92
  represent a violation?
•  
•  

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Consumer Credit Transactions

• FINANCING
• CALCULATIONS
• Loan Amount/Sales Price
• Interest Rate
• Term/No. Pmts
• Payment Amount

• TILA DISCLOSURE
• APR
• FINANCE CHARGE
• AMOUNT FINANCED
• TOTAL OF PMTS/
• TOTAL SALE PRICE

20
Consumer Credit Transactions

• It is important to note that the
• Truth-in-Lending Act does not care
• How large a value the APR is.
• How interest accrues on the loan. The Fed
  Calendar is designed to level the field.
• What rates are used for ancillary products.

21
Consumer Credit Transactions

• The bottom line is that the TILA APR is a
• back end number derived once all the
• other values have been computed.
• Mis-use of labels promotes confusion for the
  intended purpose of many disclosure items.

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Consumer Credit Transactions

• Truth-in-Lending Definitions
• Amount Financed amount disbursed to or on
  behalf of the consumer.
• Finance Charge Cost of credit as a dollar
  amount.
• Total of Payments The sum of the amount
  financed and finance charge.
• APR Cost of credit as a yearly percentage.

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Consumer Credit Transactions

• Principal Amount
• Amount to which the interest rate is applied to
  arrive at the interest charge.
• Amount Financed
• The amount disbursed to or on behalf of the
  consumer.
• What the Amount Financed is NOT is The total
  amount financed in the contract.

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Consumer Credit Transactions

• In any Credit Transaction
• Amount Financed Principal
• Finance Charge Interest
• Total of Pmts Total of Pmts
• Excluding the instance where outstanding balance
  MOB insurance or debt protection is included.

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Constructing a Transaction

• Loan Proceeds 1,000.00
• Single Credit Life Pr 11.25
• Loan Fee 30.00
• Principal Amount 1,041.25 (value used to compute
  interest)
• Less Loan Fee 30.00
• Amount Financed 1,011.25
• Interest Amount 45.59
• Plus Loan Fee 30.00
• Finance Charge 75.59
• Interest Rate 8.00 amortizes principal
  amount produces interest amount
• A.P.R. 13.52 amortizes amount
  financed produces finance charge

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Constructing a Transaction

• Loan Proceeds 1,000.00
• Single Credit Life Pr 11.25
• Loan Fee 30.00
• Principal Amount 1,041.25
• Less Loan Fee 30.00
• Amount Financed 1,011.25
• Interest Amount 45.59
• Plus Loan Fee 30.00
• Finance Charge 75.59
• Total of Payments 1,086.84
• 20 Pmts _at_ 90.57
• Interest Rate 8.00
• Amortizes Principal amount produces interest
  amount
• APR 13.52
• Amortizes Amount Financed produces Finance Charge

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Constructing a TransactionAmortization of a Loan
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Amortization of a LoanAdding a Penny to the
Payment
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Consumer Credit Transactions Interest
Computation Methods

• Parameters that shape the characteristics of a
  credit transaction
• Add-on Interest
• Simple / Actuarial Interest
• Discount Interest
• Revisiting
• I P x R x T

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Consumer Credit Transactions

• Add-On Interest
• Add-on is expressed as dollars per hundred
  dollars per year or 12 per 100 per year is
  equivalent to what is called 12 add-on.
• It is computed on the original principal amount
  for the full term of the loan as though there
  were no installments.
• Add-on was extremely popular before the prevalent
  use of computers due to ease of use using the I
  P x R x T formula. A payment can be computed
  with only pencil and paper.
• The Add-on method calculates precomputed interest.

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Consumer Credit Transactions
Add-On Interest

• Example
• 5,000 loan,
• 12 add-on interest rate,
• 36 month loan term
• I 5,000 x .12 x 36/12 1,800 interest
• 5,000 principal
• 1,800 interest
• 6,800 Total of Pmts / 36
• 188.8888888 Mo. Pmt

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Consumer Credit Transactions
Add-On Interest

• However, a real world adjustment needs to be
  made. The 1,800 represents theoretical interest
  at 12 add-on. The lender cannot collect a
  payment of 188.888888.
• Adjusting the payment to 188.88 produces new
  disclosure values.
• 188.88 x 36 6,799.68 Total of Pmts
• - 5,000.00 Principal
• 1,799.68 Interest Chg

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Consumer Credit Transactions
Add-On Interest

• The Truth-in-Lending Annual Percentage Rate using
  a payment of 188.88 is 21.196435
• The nominal simple interest equivalent or APR
  rate for 12 add-on at 36 months is generally
  listed as 21.20 in printed publications.
• If the payment were rounded up to 188.89, then
  the resulting TILA APR would be 21.200324

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Consumer Credit Transactions Rate
Book Conversions

• Add-on Rate Term Simple Rate
• 12 6 20.29
• 12 12 21.46
• 12 18 21.64
• 12 24 21.57

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Consumer Credit Transactions Rate
Book Conversions

• Add-on Rate Term Simple Rate
• 12 6 20.2880308
• 12 12 21.4571854
• 12 18 21.6426446
• 12 24 21.5712782

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Consumer Credit Transactions
Simple/Actuarial Interest

• The predominance of credit contracts in todays
  market are computed with a simple interest rate.
  This type of interest is often called actuarial
  interest to distinguish it from add-on interest.
• Whereas add-on interest is computed on the
  initial principal amount for the full term of the
  transaction, simple interest also utilizes
• I P x R x T but uses the average principal
  balance.

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Consumer Credit Transactions Process
of Amortization
38

• Sum of Outstanding Principal Balances
• 6,599.30
• 6,599.30 / 12 549.94166666 average balance
• I 549.941666 x .10 x 12/12
• 54.99416

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Consumer Credit Transactions
Discount Interest

• Discount interest is computed using IPxRxT and
  like Add-on computes a charge for a stated time
  period and disregards repayment.
• Principal with Discount interest is the total
  of payments. Thus, there is inherent compounding
  aka interest on interest associated with
  Discount interest.

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Consumer Credit Transactions
Discount Interest

• Discount Interest Example
• 1,000 face amount
• 10 Discount Interest
• 24 Month Term
• I 1,000 x .10 x 24/12 200 Interest Charge

41
Consumer Credit Transactions
Discount Interest

• The 200 precomputed interest charge
• must be subtracted from the
• face amount to arrive at the proceeds.
• 1,000 - 200 800 proceeds/amount financed
• However, a real world adjustment needs to be
  made if equal payments are desired.

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Consumer Credit Transactions
Discount Interest

• 1,000 / 24 pmts 41.666666
• If the payment is truncated to 41.66, then the
  face amount needs to be adjusted to
• 999.84 (24 x 41.66) and a new interest charge
  computed.
• I 999.84 x .10 x 24/12 199.968

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Consumer Credit Transactions
Melded/Graduated Rates

• Many small loan rate structures charge differing
  rates based on specific loan balances.
• Most of these structures are, or were, part of
  the Uniform Consumer Credit Code. These are
  referred to as code states.
• The highest interest rate is applied to the
  lowest balance.

44
Consumer Credit Transactions
Melded/Graduated Rates

• It is important to note that this is a single
  transaction with all rates integrated into the
  amortization. It is NOT a simultaneous
  liquidation of three separate loans.
• The key is that the low rate money liquidates
  first, and the high rate money liquidates
  last.

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Consumer Credit Transactions
Melded/Graduated Rates

• Example Transaction
• 36 Per Annum of the Principal to 300 plus
• 21 of the excess to 1,000 plus
• 15 of the remainder
• 1,500 Principal
• 12 Monthly Payments
• Monthly Payment 142.64
• Original Uniform Consumer Credit Code
• UCCC

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Consumer Credit Transactions
Melded/Graduated Rates
47
Consumer Credit Transactions
Melded/Graduated Rates SER Simple Equivalent
Rate
48
Precompute vs. Interest Bearing

• Two types of structures for interest in consumer
  credit transactions
• Precomputed Interest The consumer contractually
  agrees to pay the Total of Payments. Interest
  is precomputed and figured into that amount.
• Interest Bearing (aka simple interest)
  Interest accrues on the principal balance as it
  is outstanding from time to time.

49
Characteristics of Precompute

• Borrower agrees to repay 48 payments of 275.25
  or a Total of Payments of 13,212.00
• The only rate that appears on the contract is
  the Truth-in-Lending A.P.R.
• Interest accrues according to the payments as
  originally scheduled.
• A Delinquency or Late Charge is generally
  contracted for and collected to compensate for
  late payments.
• A Refund or Rebate of unearned interest is
  necessary upon prepayment in full.

50
Interest Bearing aka Simple Interest
Transactions

• Borrower agrees to repay the principal amount
  plus interest at a stated interest rate.
• The computational interest rate is included in
  the promissory note language.
• Interest accrues on the actual outstanding
  principal balances.
• Payment habits influence the principal balance at
  any point in time.
• The net payoff is the principal balance as of
  the last payment date plus accrued interest from
  that date up to the payoff date of the loan. No
  refund of interest is necessary. However, other
  charges such as single premium credit insurance
  may require a refund when the loan is paid in
  full.

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Distinguishing between Front End and
Back End Operations.

• Front End Loan Origination
• At the time of loan origination, the disclosure
  calculations must be made under the assumption
  that all payments will be made on scheduled due
  dates and in scheduled amounts.
• Back End Loan Payment Servicing
• During repayment, the timing of payments and the
  specific amounts of payments made will directly
  influence the net payoff balance of the loan.

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Precomputed vs. Interest Bearing

• Interest Bearing
• Precomputed

• Loan Proceeds 1,000.00
• Single Credit Life Pr 11.25
• Loan Fee 30.00
• Principal Amount 1,041.25
• Less Loan Fee 30.00
• Amount Financed 1,011.25
• Interest Amount 45.59
• Plus Loan Fee 30.00
• Finance Charge 75.59
• Total of Pmts 1,086.84

53
Industrial Loan Maintenance Fees

• Historically, Industrial Loan Statutes have
  allowed fees for administering the back end
  processing of the loan. Typically these fees are
  called maintenance fees as a cost of
  maintaining the loan account.
• TN and GA have such provisions and the AL Small
  Loan Statue now also allows such a fee.
• Maintenance fees are typically a dollar charge
  per month.
• The inclusion of an account maintenance fee
  introduces a new value to a transaction Face
  Amount.

54
Industrial Loan Maintenance Fees

• Loan Proceeds 1,000.00
• Single Credit Life Pr 11.25
• Loan Fee 30.00
• Principal Amount 1,041.25
• Less Loan Fee 30.00
• Amount Financed 1,011.25
• Interest Amount 45.59
• Plus Loan Fee 30.00
• Finance Charge 75.59
• Total of Pmts 1,086.84
• Add a maintenance fee of 3.00 per month/payment

55
Industrial Loan Maintenance Fees

• The addition of maintenance fees introduces a new
  value into the anatomy of a credit transaction
• FACE AMOUNT
• The Face Amount is the sum of the original
  principal plus the interest amount. Thus, it is
  one of the exceptions to the Principal Interest
  Total of Payments Rule.
• The Maintenance Fee is simply an add-on to the
  PI payment amount.
• It is indeed a Cost of Credit so it must be
  included in the Truth-in-Lending Finance Charge.
• The Maintenance Fee is added in at the back end
  of the transaction calculations.

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Industrial Loan Maintenance Fees

• Principal Amount 1,041.25
• Payment (PI) 90.57
• Interest 45.59
• Plus Loan Fee 30.00
• Plus Maint. Fee 36.00
• Finance Charge 111.59
• Total of Pmts 1,086.84

57
Industrial Loan Maintenance Fees

• Before Maintenance Fee

• After Maintenance Fee

• Loan Proceeds 1,000.00
• Single Credit Life Pr 11.25
• Loan Fee 30.00
• Principal Amount 1,041.25
• Less Loan Fee 30.00
• Amount Financed 1,011.25
• Interest Amount 45.59
• Plus Loan Fee 30.00
• Finance Charge 75.59
• Total of Pmts 1,086.84
• 12 Pmts _at_ 90.57
• TILA APR 13.52

• Principal Amount 1,041.25
• (12 PI Pmts _at_ 90.57)
• Less Loan Fee 30.00
• Amount Financed 1,011.25
  
• Interest Amount 45.59
• Plus Loan Fee 30.00
• Plus Maint. Fee 36.00
• Finance Charge 111.59
• Total of Pmts 1,122.84
• 12 Pmts _at_ 93.57
• Less Maint. Fee 36.00
• FACE AMOUNT 1,086.84
• TILA APR 19.78

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Anatomy of a Credit Transaction

• Interest Rate 8.00
• Loan Proceeds 1,000.00
• Single Credit Life Pr 11.25
• Loan Fee 30.00
• Principal Amount 1,041.25
• Less Loan Fee 30.00
• Amount Financed 1,011.25
• Interest Amount 45.59
• Plus Loan Fee 30.00
• Finance Charge 75.59
• Total of Pmts 1,086.84
• 12 Pmts _at_ 90.57
• TILA APR 13.52