Single Payment Transactions and Mixed Fruit Results

In the last few months we have had a number of inquiries from clients about how to pass our calculation engine the right information for single advance, single payment transactions. 

There seems to be a degree of uncertainty when dealing with these types of loans. 

Maybe it's because these types of transactions represent the simplest calculations that we do and the expectation is that the concept should be more difficult.  In reality, it is a linear I = P x R x T type environment and there aren't the thousands of behind the scenes iterations that are necessary to compute a precisely integrated declining balance closed end credit transaction.

It seems the first inclination is for a system to collect and pass us the information as though it were a monthly transaction with a series of $0.00 payments followed by one "balloon payment" at maturity.  For instance, a twelve month single pay loan would have 11 $0.00 payments and then one large payment of principal and interest.

That situation may seem analogous to a single payment transaction but it poses two prominent issues with regards to the disclosure computations.

The first is that when assumed to be 'monthly' in nature, interest accrues on a theoretical monthly basis and presents potential rounding options.  Traditional near rounding as in periodic transactions can create an interest charge that is materially larger than a linear calculation where the only rounding is done once at completion.

The more significant issue is the Truth in Lending APR calculation.  The rules in Appendix J of Regulation Z recognize 'events' in order to establish a unit period for APR computation.  Payments of $0.00 are viewed as events, regardless of dollar amount, in order to take into account the time value of money.  That practice establishes the unit period for APR computation as monthly rather than the term of the transaction as prescribed in Appendix J.

The result is that the APR computed for a monthly unit period with 11 $0.00 payments and a final of $10,799.80 for a $10,000 loan is 7.719%.  Computed properly as a single advance, single payment loan the accurate APR disclosure is 7.998%.  The difference of .279% is well outside the 1/8 of 1 percent tolerance Regulation Z allows.

There are instances where our communication is initially hindered by the use of labels.  Since we are creating routines to ensure compliance with regulatory requirements, the labels we use have strict definitions per the appropriate regulation.  A specific lender, however, may develop names for lending programs internally within their institution that have a more esoteric meaning.

We view "single payment" as a transaction where the borrower makes only one payment during the life of the loan.  We have seen the term "single payment" used to also characterize a loan program where interest only payments are required and a single principal and interest payment is due at maturity.  Those two instances, both named "single payment" require separate and distinct procedures for computing the Truth in Lending annual percentage rate.

It is vitally important to keep units of measure and other pertinent characteristics consistent when performing any consumer credit calculation.  Rather than "apples and apples" the result may be a fruit salad not pleasant to the compliance taste buds of the lender.