March 13, 2013
Most loan docs for consumer installment type loans have a field called ‘Finance Charge’ which is supposed to represent the amount of interest that you would pay if you made each and every payment on this loan on its due date; never early and never late. If you compare this to the total amount of interest payments in the NLS amortization schedule, or to the Finance Charge field in our origination module, you may find a slight discrepancy. This is because the common loan origination and documentation programs only approximate this finance charge.
Lenders can get away with approximating the finance charge because they know that this figure is going to deviate the first time that the borrower makes his payment on any day other than the due date. Usually this occurs the first month. So, they aren’t going to go too far toward making sure they have an accurate figure for finance charge, since it is likely going to go the way of the dinosaurs before the first month is done.
Let’s take a closer look.
I’ll give you a rundown of a simple loan and then an explanation of how the finance charge would be calculated by most origination systems including the Nortridge Loan System.
Here’s the premise: $ 1000.00 lent at a 10% interest rate for one year with 12 monthly payments. The monthly payment amount is $ 87.92.
Lenders would calculate the finance charge as follows:
$ 87.92 x 12 = 1055.04
1055.04 – 1000.00 = 55.04
Simple. Easy as pie. But it is not really that simple.
$87.92 is the best fit payment for this principal amount at this rate over this term, but that does not mean that it is actually the payoff on the due date. Ultimately, the final payment will usually deviate from the other payments by some small amount. So, we run the loan through the amortization schedule in memory and see what comes out the other side:
|
Pmt # |
Payment |
Principal |
Interest |
Balance |
|
|
|
|
|
1000.00 |
|
1 |
87.92 |
79.59 |
8.33 |
920.41 |
|
2 |
87.92 |
80.25 |
7.67 |
840.16 |
|
3 |
87.92 |
80.92 |
7.00 |
759.24 |
|
4 |
87.92 |
81.59 |
6.33 |
677.65 |
|
5 |
87.92 |
82.28 |
5.64 |
595.37 |
|
6 |
87.92 |
82.95 |
4.97 |
512.42 |
|
7 |
87.92 |
83.65 |
4.27 |
428.77 |
|
8 |
87.92 |
84.35 |
3.57 |
344.42 |
|
9 |
87.92 |
85.05 |
2.87 |
259.37 |
|
10 |
87.92 |
85.76 |
2.16 |
173.61 |
|
11 |
87.92 |
86.47 |
1.45 |
87.14 |
|
12 |
87.86 |
87.14 |
.72 |
0.00 |
|
GRAND TOTALS |
1054.98 |
1000.00 |
54.98 |
|
The difference is only six cents, but that was over 12 payments. And that is just the difference caused by the fact that we have to round each payment to the nearest cent.
So, when your loan docs say the finance charge is $55.04 and the servicing systems says that even if the borrower made all of their payments exactly on the due date (never going to happen) the finance charge is only $ 54.98, don’t assume a calculation problem in your servicing system. The issue is actually a higher degree of precision.
