When it comes to computing consumer financial calculations, precision and accuracy are paramount. Whether you’re calculating TILA APRs, finance charges, or loan payoffs, relying on the wrong tools can lead to compliance risks, misleading audit results, and even financial penalties. Case in point—although the Federal Financial Institutions Examination Council (FFIEC) APR Calculator is easily accessible and commonly used throughout the industry by both lenders and regulators, it is important to be aware of the tool’s limitations that could throw off your calculations and potentially increase your compliance risk.

Limitation #1: February 28 

A key factor to consider when using any financial calculation tool is how it handles non-standard or edge-case dates or other loan terms. For instance, the FFIEC tool—which is free and widely used for checking TILA APR compliance—makes assumptions on loans with a first payment date of February 28. This can be especially problematic for transactions with particular or irregular payment dates and where precise day-counting methods matter.

When February 28 is entered as a payment date, the FFIEC calculator appears to assume it is the last day of the month rather than an anniversary date. The tool is incapable of calculating accurate APRs for transactions that include a payment date on the actual date of February 28, and that is not a recurring payment on the last day of the month.

In this case, relying solely on the FFIEC calculator to verify disclosed APRs (while also assuming February 28 was the last day of the month) could result in the APRs being inaccurate and even out of tolerance with the precise rules outlined in Appendix J to Regulation Z.

Keep in mind that reliance on the FFIEC calculator does not create a safe harbor for lenders.

Limitation #2: Declaring the Unit-Period 

Another limitation of the FFIEC calculator is that it requires the user at the outset to declare the transaction’s unit-period—the most frequently occurring period between advances and/or scheduled payments. In contrast, the precise rules outlined in Appendix J require solving for a unit-period. For transactions where the payment schedule is irregular and the unit-period isn’t obvious, having to declare the unit-period when inputting the transaction data could result in a unit-period that does not align with what would be determined following the rules and structure of Appendix J. And in the end, this could unintentionally mislead the FFIEC calculator and result in an erroneous APR.

For transactions with even slightly irregular payment schedules, assuming the unit-period is obvious could lead you down the wrong path. And depending on the other terms of the transaction, it could result in even a slight difference, such as declaring:

• A unit-period of 1 semi-month instead of 13 days

• 1 month instead of 30 days

While these differences may seem negligible, declaring the wrong unit-period can be enough for the FFIEC calculator to compute a TILA APR that is out of tolerance.

Limitation #3: Inability to Calculate a U.S. Rule APR

Appendix J to Regulation Z outlines two methods for computing an accurate TILA APR: the actuarial method and the U.S. Rule method. Appendix J does not state that a lender must follow the exact mechanics to arrive at their disclosed APRs, but that these disclosed values will be evaluated against APRs computed by the rules outlined in Appendix J.

A clear limitation of the FFIEC calculator is that it cannot calculate a U.S. Rule APR. Largely for this reason, many in the industry choose to disclose APRs calculated using the actuarial method. It always helps for lenders to be able to “prove” their numbers, especially when most regulators are using tools like the FFIEC calculator during their examinations. That said, Appendix J explicitly permits APRs calculated using the U.S. Rule method. Lenders choosing this method just may need to find other ways to validate their numbers.

Key Takeaways:

Keep these things in mind when using any calculation tool for validation:

• Understand the tool’s quirks and limitations, especially when it comes to irregular or edge-case transactions.

• Remember the results are highly dependent on the data inputs and precision matters. Garbage in, garbage out.

• Consider an independent third-party review, especially if you’re relying on the FFIEC calculator or other limited tools to perform calculations. This added level of quality assurance helps validate your calculations for internal purposes or to meet the needs of a third-party business relationship or regulator.

Spring is the perfect time to refresh and reorganize—not just your home, but your loan portfolio as well. Whether you’re originating, buying, or servicing consumer loans, ensuring your portfolio is compliant requires thorough calculation checks. Just as clutter accumulates unnoticed in your home, financial calculation errors can quietly accumulate in your loan portfolio, leading to compliance risks and financial inaccuracies.

The Importance of Accurate Calculations

Accurate calculations in consumer lending are essential. Errors can lead to regulatory scrutiny, financial loss, and reputational damage. Many systems today still rely on basic checks, typically using a simple “rate compare” method—comparing a loan’s stated interest rate or TILA APR against state maximums. Although straightforward, this method often misses complex nuances inherent in modern loan transactions.

Historically, loan structures were standardized, making periodic interest calculations and uniform repayment schedules common. A simple rate check was usually sufficient. Today, loan structures have evolved significantly. Loans often include daily interest accrual, extended repayment periods, various types of fees, and varied schedules for first payments—each adding layers of complexity.

Regulatory Reality vs. Simple Rate Checks

Most state regulations don’t simply cap interest rates or APRs. Rather, regulations usually define the maximum charge allowable, considering both the stated rate and how the interest is computed and applied. As loans increasingly incorporate varied and complex terms, the potential for regulatory noncompliance grows significantly.

Ensuring Comprehensive Compliance

At Carleton, we specialize in performing comprehensive checks beyond basic rate comparisons. We analyze complex loan structures (e.g., melded rates, stepped rates, add-on rate conversions) and verify compliance based on total charges, ensuring your loans fully align with state regulations.

Carleton’s Solutions for Your Loan Portfolio

• Bulk Portfolio Reviews: Quickly identify discrepancies and compliance risks across your entire portfolio. These can be done once or on a recurring basis (monthly, quarterly, annually).
• Live Transaction Checks: Integrate compliance checks directly into your origination or purchasing processes through the use of our APIs, ensuring real-time compliance.

Steps to Begin Your Spring Cleaning

1. Review Current Calculation Methods: Understand whether your interest accrual methods and payment structures are standardized or varied. When was the last time your institution’s methods were reviewed against the nuanced state requirements?
2. Audit Your Portfolio: Utilize bulk data reviews to identify noncompliant loans or implement live checks on an ongoing basis.

 

Learn More About Our Compliance Solutions

When it comes to consumer finance, the application of an interest rate is a core factor affecting the soundness of the calculations. But not all interest rates are alike!

Over the years, different methods of calculating interest have been used in the consumer finance industry, each affecting both payment calculations and interest calculations. State guidelines differ in the way they describe interest rates, and in turn how they judge the total charge allowed for a consumer credit transaction.

Simply put, a 10% add-on interest rate is not equivalent to a 10% simple interest rate. Because of the underlying definitional assumptions, these rates are inherently unequal.

Below, we explore the differences between these two interest calculations.

What Is Add-On Interest?

Add-on interest is a method that calculates interest on the initial loan balance rather than on the outstanding principal. In this structure, the lender calculates the total interest due at the beginning of the loan and “adds” it to the principal balance. The result is then divided by the number of payments, giving borrowers equal monthly payments over the term. If the consumer pays the loan off early, the consumer is due a refund. Add-on interest is a linear calculation.

What Is Simple Interest?

In a simple interest loan, the lender calculates interest daily based on the remaining principal. The calculations are computed up front, but the principal and interest balance will vary over the life of the loan based on the repayment. If the consumer pays a loan off early, there is generally no refund required because the interest has only been assessed and paid for days actually elapsed, not for the entirety of the loan.

Historical Context

• Add-on interest was once more common than it is today, particularly in consumer installment loans. The appeal was its simplicity: the calculations were far more straightforward, relying on the standard Interest = Principal x Rate x Time calculation. Additionally, it could be done using paper and a pencil in front of a customer to arrive at a total charge for credit. The fixed payment structure was easier to compute, remember, and understand. Today, only a few states still use add-on interest as their method for evaluating maximum rates.

• Simple interest has become the predominant method for calculating interest in consumer credit. Historically, add-on interest was favored for its simpler math, but advancements in computing power have eliminated the need for such simplifications. Modern software easily handles more complex amortization schedules, accurately reflecting daily interest accrual.

Add-On Interest vs. Simple Interest: How It’s Calculated

• Add-On Interest: This is calculated periodically—typically on a monthly basis—meaning there is no daily adjustment for the declining principal.
  • Add-on interest differs from simple interest, where the interest accrues daily on the remaining loan balance.
  • This straightforward approach requires minimal adjustments or calculations after loan origination unless the loan is paid off early.

• Simple Interest: In a simple interest loan, interest accumulates based on the loan’s principal balance each day.
  • This daily calculation reflects the actual balance of principal plus interest that a borrower owes at any given time.
  • Since the principal balance changes daily as payments are applied, lenders must use a more iterative process to calculate interest and principal over the life of the loan.
  • This complexity can require more sophisticated calculation systems to ensure that each payment is applied and interest is calculated correctly.

Terminology Examples

• Add-On Interest: “$10 per $100 per year.”¹

• Simple Interest: “twenty-five percent (25%) per year.”²

Key Takeaways

• Add-on interest loans give borrowers a fixed monthly payment.

• Simple interest loans provide flexibility and account for daily accrual.

• With today’s computing power, add-on interest has largely become a thing of the past.

• As states continue to use language in their statutes that reference add-on interest rates, it is important to understand the key differences in these interest types.

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¹ Fla. Stat. § 520.08(1)(a)

² IN Code § 24-4.5-6-201

Recent actions under the new Administration have raised questions about the future of the Consumer Financial Protection Bureau. As efforts to curtail or potentially dismantle the agency intensify, many in the lending industry are wondering what effect this could have on lending policies.

Even if the CFPB is stripped of much of its authority or dismantled entirely, the laws that it enforces remain in effect unless formally repealed or modified.

The CFPB was created under the Dodd-Frank Act to enforce a variety of consumer protection laws, including:

• Truth in Lending Act (TILA)
• Real Estate Settlement Procedures Act (RESPA), which is now largely governed under the TILA-RESPA Integrated Disclosure (TRID) rules
• Fair Credit Reporting Act (FCRA)
• Equal Credit Opportunity Act (ECOA)

If the CFPB’s power is reduced, that does not automatically mean these laws disappear. For example, TILA and TRID rules will still govern mortgage disclosures, loan agreements, and credit provisions. The regulatory frameworks they establish will continue to apply to lenders unless repealed by Congress or modified through proper rulemaking procedures.

State Attorneys General Have Enforcement Power

Even if the federal enforcement of consumer protection laws wanes, state governments may fill the void. Under Section 1042 of the Dodd-Frank Act, state attorneys general (AGs) are empowered to enforce federal consumer protection laws.

This means that state AGs can—and likely will—take action to enforce key consumer financial protections if federal enforcement diminishes. State attorneys general have a long history of enforcing consumer protection laws independently, and many are expected to maintain this role in the absence of federal oversight.

Compliance Is Still Critical

Whether the CFPB is diminished or not, financial institutions must remain vigilant. TILA and TRID regulations, among others, still require accurate disclosures, correct loan calculations, and adherence to consumer protections. While a reduced CFPB may lead to changes in enforcement priorities, the legal obligations of lenders and financial institutions remain the same until laws are formally changed or repealed.

 

Disclaimer: This blog post is for informational purposes only and does not constitute legal advice. Consult a qualified attorney for guidance specific to your situation.

GDS Link, a global leader in credit-risk decisioning solutions, features Carleton’s General Counsel and Vice President of Compliance, Sarah Milovich, as a special guest on their podcast, The Lending Link. In this episode, their host Rich Alterman, sits down with Sarah to discuss the critical role of the Truth in Lending Act (TILA), compliant Annual Percentage Rate (APR) calculations, and other complexities and challenges lenders face in the consumer finance industry.

Sarah talks about her journey from corporate attorney to her current role, offering a behind-the-scenes look at Carleton’s long history of providing critical compliance solutions to major lending organizations. She then shares insight on the growing use of Artificial Intelligence (AI) in compliance along with providing some advice to any upcoming law school students!

Listen to the full episode now!

Apple Podcasts: https://apple.co/40f4yIK

Spotify: https://bit.ly/4h7JIkB

YouTube: https://bit.ly/3NBtkLw

About Carleton:

Carleton is the country’s leading provider of financial calculation software, loan origination compliance support, and document generation software. With over 55 years of experience, our ongoing expertise and industry knowledge reaffirms why Carleton is a trusted partner. Founded in conjunction with the Truth In Lending Act, Carleton provides expert compliance support with continuous accuracy in all our calculations and disclosures at a state and federal level.

About GDS Link: 

GDS Link is a global leader in credit-risk and decisioning solutions, boasting over 18 years of experience. Specializing in data aggregation, advanced analytics, and responsive decisioning, GDS Link’s comprehensive solutions currently deliver over a billion decisions annually, enhancing the customer journey and making a significant impact for clients across 46 countries. The company’s expertise is bolstered by strong strategic partnerships in financial services and technology, enhancing credit risk management and business growth.

About The Lending Link Podcast:

The Lending Link, powered by GDS Link, is a podcast hosted by Rich Alterman and designed for the modern-day lender. Each episode dives deep into innovation within the financial services industry and transformation efforts, including AI/ML integration, modeling, risk management tactics, and redefining customer experiences. GDS Link launched The Lending Link to explore unique strategies for the modern-day lender, dive into the innovative advancements GDS Link and their partners are currently developing and delivering, and gain insights from captivating guests within the fintech, banking, and credit union worlds. They feature a wide range of guests from various lending institutions and diverse organizations who share their strategies, technology insights, and everything in between.

Over the past decade, we’ve seen a rise in various flavors of “All-in” Annual Percentage Rate (“APR”) legislation. States are evolving in how they regulate interest. One notable piece of this evolution is the movement toward adopting rate caps tied to all-in APRs rather than a traditional charge based solely on interest rates. This shift is significant for both lenders and borrowers, bringing new opportunities and challenges to the consumer installment lending industry.

All-In APR vs. Traditional TILA APR: What’s the Difference?

To understand this trend, it’s essential to distinguish between the traditional APR, as defined by the Truth in Lending Act (“TILA”), and an all-in APR.

• Traditional TILA APR: This rate is a measure of the consumer’s cost of credit, expressed as a yearly rate based on the rules outlined in Appendix J to Regulation Z. This calculation takes into account the interest rate plus any additional fees that are considered finance charges under TILA.
• All-In APR: By contrast, this rate is intended to provide a more comprehensive assessment of the consumer’s cost of borrowing. However, states’ definitions of “all-in” vary and can encompass a variety of additional fees that are not considered finance charges under TILA. The most prevalent example of this is the inclusion of optional credit insurance.

Examples of States Where All-In APR Legislation Has Gained Traction

• South Dakota: In 2016, a ballot resolution implemented a 36% All-in APR for loans. The resolution sent shock waves throughout the industry due to the nature of the change.
• Illinois: The Illinois Predatory Loan Prevention Act, enacted in 2021, also set a 36% All-in APR cap on most consumer loans. This legislation tied the APR to the Military Lending Act’s calculation requirement and impacted retail sales and loans.
• New Mexico: Beginning January 1, 2023, New Mexico instituted an All-in APR of 36% for loans up to $10,000. The loans required the state APR calculation to include products in connection or concurrent with the extension of credit, and any credit insurance premium or fee.

All-In APR Caps: Concerns and Implications

The shift toward all-in APR caps raises several concerns for the consumer lending industry:

• Access to Credit: Lenders argue that strict all-in APR caps could reduce access to credit for consumers, particularly those with subprime credit scores, as lenders may find it unprofitable to offer loans under such stringent conditions and at the effectively lower rates.
• Operational Complexity: Calculating an all-in APR is more complex than determining a traditional TILA APR. This complexity could increase compliance costs for lenders and be particularly burdensome for smaller institutions, potentially leading to higher costs for consumers. In addition, there is confusion over which rates to display on the contract. The all-in APR does not replace the TILA APR, but this confusion remains among lenders and consumers alike.
• Statutory Ambiguity: Some statutory language includes vague language such as the inclusion of fees “in connection with or concurrent to” a loan agreement. Such language leads to uncertainty over whether items like late fees must be included in the all-in APR calculation. These fees, which are incurred after consummation of a loan, alter the fundamental concept of origination disclosures.

What Does the Future of All-In APR Caps Look Like?

As more states consider or implement all-in APR caps, it’s clear that the consumer lending landscape is changing. Lenders must stay informed about these developments and consider how they may need to adapt their business models to comply with new regulations quickly and compliantly.

For lenders and borrowers alike, the shift toward all-in APR caps marks a significant change to the industry. Staying ahead of these trends and understanding their implications is crucial for anyone involved in consumer lending.

In what seems like the blink of an eye, four years have passed and another Leap Year is upon us. One extra day to make up for the fact that it actually takes a little longer than 365 days for the Earth to orbit the Sun. In honor of both Groundhog’s Day and the mysterious Leap Day, we thought it would be worthwhile to recycle one of our “oldie but goodie” articles on the complications Leap Day poses on consumer loan calculations.

While most people consider February 29th to be a “free” day we get every four years, compliance officials and loan calculation software providers know that it can actually be more troublesome than most people would even realize. In the consumer lending industry, the various effects of Leap Day on loan origination, 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, during a Leap Year:

Top 3 Questions For The Consumer Lending Industry to Consider During a Leap Year

Question #1: 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 for that month than any identical transaction originated the following three years on the exact same date and time. That does not seem fair or just.

Question #2: 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 29th 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?

Question #3: If a payment is received and posted on Leap Day, is it recognized as 2/29/24?

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 happens when a payment occurs on Leap Day? Seems like it would make posting a payment on February 29th very problematic. This may seem extreme, but should that bank even be OPEN on February 29th?

 

While this may seem like it’s all simply an academic exercise, for many lenders, Leap Year does indeed impact the nuts and bolts of calculating principal and interest. It is also critical that Leap Year is properly accounted for 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 loan calculation needs.

Well, it is the Carleton Compliance Team’s favorite time of the year! Legislatures are back in full swing, and new bills have popped up potentially affecting consumer credit all over the country. Colorado, Connecticut, Indiana, Oklahoma, South Carolina (among others)—all have legislation that has been introduced or pre-filed which contain a new rate cap determining what lenders can charge for making small loans.

While we joke about new laws affecting the consumer credit industry, we recognize these laws have significant impacts on our industry. One point that rarely gets addressed when these types of new bills are debated is the ramifications for a lender of mistakenly tying a state’s rate caps to a Truth in Lending Act (“TILA”) Annual Percentage Rate (“APR”). In the rush to draft new rate caps or to interpret the legislation, key concepts quickly get overlooked. And basic consumer math criteria get conflated.

So, what does it mean when a state ties its lending laws to the Truth in Lending Act?

That’s right. It gets complicated! As we field more and more compliance-related questions, we are always a bit surprised that the “Maximum APR” viewpoint is still so prevalent in the consumer finance industry (“All-in” rate caps aside).

The fact is, most consumer lending statutes continue to regulate the dollar amount of the charge, whether it’s referred to as interest, finance charge, or time-price differential. The dollar charge is created by applying the published maximum rate to the outstanding balances of the transaction. How that rate is applied is key.

The Truth in Lending Act’s Actuarial Method was created to “level the playing field” when computing an APR for comparison sake. To achieve that goal, TILA proscribes the use of the Federal Calendar and disregards how a specific creditor actually computes dollar interest charges. How? By the use of a calendar which is periodic in nature–the Federal Calendar.

In contrast, in many cases, the state-prescribed calendar for determining the maximum charge differs from the one used to compute the TILA APR. In such an instance, the APR is not necessarily an accurate barometer of compliance with a state statutory provision or the maximum charge allowed.

Furthermore, in today’s context, you have to assess the effect of “simple interest”, which often corresponds to daily charge accrual. Many statutes are rather antiquated and originally constructed in a time when daily interest was not the norm. Rate caps may have been updated, but other code provisions written in a time where periodic calculations were the norm may have been left behind.

Another complicating factor is that by necessity, the TILA APR is generally disclosed as a two or three place decimal value. The rate has to fit in the “Fed Box”, which means it is a rounded value. Quite often the TILA APR, rounded for the purpose of display, can provide a false sense of compliance. Applying that rounded rate can, in certain conditions, produce an overcharge for specific loans using the state’s prescribed requirements.

So, is it possible for a transaction with a disclosed 21% TILA APR to also exceed a 21% statutory maximum rate applied on a daily basis and thus represent a potential violation?

Yes! The devil is in the details! In conclusion, be wary of new state laws that appear to be tied to an “APR” cap.

Fortunately, Carleton’s compliance team specializes in monitoring federal and state regulation changes across all 50 states.  With over 75 combined years of experience among our staff attorneys and compliance personnel, we help provide our clients that peace of mind knowing our solutions and services have compliance embedded.

To learn more about Carleton’s compliance services, click here or contact us directly.

*This article was updated from the original thought leadership blog “Maximum Finance Charges…It’s Not Just the Rate” 

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 the 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.

In Part 1 of this Thought Leadership series on simple interest, Carleton discussed how simple interest transactions have complicated previously held beliefs about consumer credit computations. While periodic interest calculations may closely align and appear identical to actuarial method APR computations, simple interest calculations do not always follow suit.

By measuring actual days elapsed and not simply counting a month as 1/12 of a year, simple interest added a layer of complexity to what was previously considered “easy” math.

Part 2 addresses another complication brought about by the use of simple interest—the fact that there can be multiple “right” payments.

Simple interest’s biggest impact can be seen when prospective interest charges accrue on the actual calendar days elapsed between scheduled payment dates. This is a departure from the historical “periodic” interest charges that accompanied precomputed transactions. For the purpose of interest accrual, periodic interest considers all months equal and interest accrues at 1/12 the stated annual interest rate. Periodic interest does not recognize that months have differing numbers of days.

Why is that important? Because merely looking at the stated interest rate leaves a skewed picture. The rate is merely one component of the process. The application of the rate to accrue interest is often the overlooked key parameter. Simply put, this is the reason we see such confusion in the credit industry when the contract interest rate and Truth in Lending Act (“TILA”) annual percentage rate (“APR”) are not the same value.

Click here to access the printable PDF of this publication

Key Considerations Regarding Simple Interest

1. There are different methods of accrual calendars and the month in which the loan originates
2. When accounting for a maximum charge on a loan, loan data must be evaluated when using applicable parameters identified in statutes

Urban Myths

Part 1 addressed the first urban myth that: “If there are no fees included in the finance charge, the interest rate and APR are the same.”

Urban Myth #2: There is only one “right” payment for a set of data

With simple interest, a set of data could potentially have a dozen different amortizing payments depending on the month in which it was originated. The amount of interest calculated on using a daily accrual method is dependent upon the month of origination and the number of days of interest which accrue early in the transaction. For that reason, the exact same set of data will accrue less interest on a deal beginning in February (28 days) than one that begins in March (31 days). If there are more days accruing interest at the beginning of a loan when the balances are at their highest, the entire profile of prospective interest accrual changes. So too does the comparison between the applied interest rate and the APR when utilizing a periodic calendar vs. a daily accrual calendar.

Carleton has seen at least 13 different payment accrual calendars, all utilizing different combinations of time counting, including for example: periodic or daily accrual, counting 365 days a year or 366 days a year on leap year, or counting whole months and days. Based on these different methods of accrual calendars and the month in which the loan originates, there can be varying effects on the applicable amortizing payment and interest calculations.

Urban Myth #3: A State’s maximum rate provision is simply a nominal rate comparison. The method of charge accrual is irrelevant

So how do regulators view the industry shift towards simple interest? Many jurisdictions’ statutes written in the 1970’s and 1980’s state that for the purposes of computing the maximum finance/credit service charge “the differences in the lengths of months are disregarded.” That would imply that a periodic calendar is to be used when determining if there is an overcharge.  The key point here is that a majority of state statutes regulate the dollar charge contracted for by the creditor.  So, the application of the published maximum rate becomes a crucial data point.

Even when a statute employs language that makes the maximum rate synonymous with the TILA Appendix J APR value, Appendix J allows a compliant APR to be computed by both the actuarial and U.S. Rule methods.  Often, the methods return identical results, but just as often they provide distinct APR values.  So, which one is “right”?

This notion can be illustrated when the consequences of applying a daily interest rate of 18% results in a TILA APR of 18.03% (which uses the periodic calendar). That means that if the differences in the lengths of months are disregarded, the effective interest rate is 18.03%. But when a daily calendar is used, the effective interest rate is 18%. Using the effective interest rate of 18.03% technically results in a violation of the maximum charge provisions in the statute. This violation is a result of a daily calendar used to accrue interest charges and another mandated to assess the result. If an actuarial method APR is disclosed, the APR box itself may be evidence of an overcharge.

Of course, a creditor can compute and disclose an APR by the United States Rule method and employ daily charge accrual. In that situation, the interest method and APR method are identical resulting in an APR which will match the interest rate.

One practical consideration that needs to be made by disclosing parties is that nearly every examiner in the United States carries a free download of the OCC’s APRWIN Software Program on their laptop. APRWIN is a credible tool, but it only computes by the actuarial method APR and cannot validate a U.S. Rule value. A creditor needs to be able to strongly justify and prove their APR disclosures at every examination—it’s a fact that most don’t have the proper tools to do so.

One final operational effect of the movement from the precomputed environment is the difficulty of porting a TILA APR into a servicing system to accrue actual interest earnings and service the loan. One of the main features of a precomputed contract is that the consumer is agreeing to repay a total of payments and that is synonymous with the rate found in the APR. When the APR and contract interest rate were interchangeable—during the era of precomputed contracts—the practice of porting an APR into the service system was widespread. Now, when utilizing daily simple interest the resulting APR for an 18% contract interest rate may be anywhere from 17.97% to 18.04%.

Thus, when accounting for a maximum charge on a loan, the loan data must be evaluated when using the applicable parameters identified in the statute.

Keeping it Simple: Resources for Compliance

Carleton’s products and services are synonymous with consumer credit calculation compliance since 1969. Priority is given to maintain its position as the industry’s leading authority with respect to loan calculation accuracy.

Carleton clients receive compliance support from Carleton’s Compliance team in three critical areas: constant monitoring for change in regulations through state and federal databases, continual testing and implementation of new quality control methods to ensure software calculation accuracy, and litigation support providing backup in any client legal support needs, including:

• State & Federal Law Database – Carleton’s Compliance Department maintains a regulatory library and constantly monitors changes in state and federal regulations related to loan calculations. Carleton is also able to remain at the forefront of breaking legislative developments through a myriad of subscription services related to lending, professional legal relationships, active participation on law committees of national lending associations, and the compliance departments of many of the major lenders who are clients of Carleton.
• Verification of Calculations – Our Compliance Department is involved in designing programs to test the accuracy of all Carleton calculations and ensures that an updated quality control program is in place to support the changes in regulatory compliance for all state and federal regulations.
• Litigation Support – As part of Carleton’s maintenance and customer support, the Compliance Department is available as a resource to assist clients in providing the basis of the computations and validation of the calculation accuracy in the event a state or federal examination results in a requirement to defend or explain our company’s loan computations.

Carleton, Inc. also provides a range of Compliance Support Services, including:

• TILA Reimbursement & Adjustment Calculations
• Recasting of loans
• Creating amortization Schedules to “prove” a lending transaction
• Examination support through providing dollar and cent illustrations
• Analysis of client’s internal system calculation requirements

Carleton, Inc. is the leading provider of compliant lending and leasing calculation software and dynamic document generation software serving the banking, credit union, and auto lending industry.  Founded on compliance expertise at a federal and state level in 1969, the company’s client list has grown to include most of the major lenders, credit insurance companies, and loan origination software providers in the United States.