The APR: Semi-monthly Complications

There has been a marked increase over the past couple of years in credit plans being tailored to the payroll frequencies of respective borrowers and retail buyers.  Creditors like the security of scheduling payments in accordance with how their customers get paid by their employers.

Sounds simple enough but like nearly everything surrounding consumer credit calculations, some of these options can be a bit tricky as far as producing accurate Truth in Lending disclosures.  Particularly, the annual percentage rate.

Take, for instance, borrowers who get paid only once a month.  Very typically that event occurs on the last day of every month. Appendix J of Regulation Z has particular language dealing with payments scheduled  on the last day of each month.  Like many other scenarios, the techniques used to enter and exit the month of February generally take special code to account for the fact that the month on either side of February contains 31 calendar days while February itself has only 28, or perhaps 29 if it's leap year.

Even more perplexing, and nearly universally misunderstood, are the rules for computing the APR when the repayment period is "semi-monthly" constituting 24 payments in each calendar year.  It doesn't take an advanced math degree to figure that 2 payments per month during a year that contains 365 calendar days is going to create some unique time periods.

Too often we see systems encounter the pitfall of declaring a semi-monthly period to be 15 days long.  Part of that is fueled by the language in Appendix J for determining the fractional unit period in a semi-monthly scenario by dividing by 15.  That value is evident, so programmers run with it.

However, remember that the Appendix J unit period concept is the "common period that occurs most often".

If a computing routine declares that a semi-month period is every 15 days, then the period occurring most frequently, and hence the unit period for the APR, is exactly that: 15 days.  And...that is not a "semi-month".  24 payments per year every 15 days still leaves 5 calendar days unaccounted for.

A 15 day unit period will produce a distinct APR value when compared to one using a semi-month for the same transaction data.

It's an easy trap to fall into and we see the results from originating systems on a regular basis.