Thought Leadership

2020 is a Leap Year! How Do Lenders “Properly” Account for it in Their Loan Computations?

I have always been intrigued by the mysterious “free” day that appears every Leap Year. Many questions come quickly to mind. For instance, how would one discover a year was not actually a full year in the first place? Or was there any pushback against Caesar's changes to the calendar? (He was a dictator, so probably not much.) And, what possible advantages would having a birthday on Leap Year actually provide? Spoiler alert: nothing tangible.

As compliance officials and loan calculation software providers know, Leap Day isn't a free day. In fact, it can be more troublesome than many would care to discover. In the consumer lending industry, the various effects of Leap Day on loan origination and loan servicing  systems and the compliant implementation of proper loan software parameters are quietly downplayed. That shouldn't be the case! As we at Carleton have stated before: simple interest quickly becomes quite complicated. For starters:

• Does interest accrue on the balance at 1/366 of the annual interest rate? Or 1/365?

Is it 'fair' for the creditor to get a lesser charge all year long when Leap Day only occurs in February? An illustration: a consumer loan or retail installment sales contract originated in December of a Leap Year involving simple interest at 1/366 daily rate will always receive less charge than any identical transaction originated the following three years on the exact same date and time. That does not seem fair or just. Here is another:

• Does a finance company or lender's servicing system collect the actual interest agreed to by contract?

If a 1/365 annual interest rate is used to calculate daily charge, does the creditor intend to collect interest on February 29^th or not? If the consumer lending organization does charge interest on Leap Day, does that align with their contractual disclosures? Frankly, these are questions that may even be too advanced—do all servicing systems even have the capability of accounting for Leap Day? Finally, one more:

• If a payment is received and posted on Leap Day, is it recognized as 2/29/20? 

For banks and institutions that ignore Leap Year altogether and have coded their loan origination and loan servicing software systems to do the same, what actually occurs on Leap Day? Seems like it would make posting a payment on February 29^th very problematic. This may seem tongue-in-cheek, but should that bank even be OPEN on February 29^th?

These are just a few of the types of questions that intrigue me now regarding our free day. My largest wonder is whether it's all simply an academic exercise or does Leap Year indeed impact the nuts and bolts of principal and interest. Either way, there definitely are ramifications for having a year which is 365 days, 5 hours, 48 minutes, and 46 seconds long. 

It is critical that leap year is properly accounted for and in alignment between front and back end systems to ensure compliance with state and federal regulations. Contact us today for an evaluation and learn how Carleton can handle your compliance needs.

Written by Brian Kelly 

Compliance Associate