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Consumer Credit Regulation: 5.8.7.2 Pro Rata Rebates

The simplest but least used rebate formula is the pro rata method. This formula assumes that interest is earned in direct proportion to the time that a loan or credit has been outstanding. If a prepayment occurs four months into the term of a precomputed loan that was scheduled to be repaid in twelve months, the pro rata method provides that 4/12 of the interest has been earned. Consequently, the remaining 8/12 of the interest is unearned and must be rebated.

Consumer Credit Regulation: 5.8.7.3.1 Background and legal status

As the reader who has been introduced to the Rule of 78s in other parts of this treatise may have gathered,510 this method of calculating rebates is a bane to consumers and a boon to creditors. It is also an anachronism; since the advent of widely available computers, there is no reason for it other than to maximize income for creditors.511

Consumer Credit Regulation: 5.8.7.3.2 Calculating a Rule of 78s rebate: a simplified step-by-step guide for mathphobes

When Congress enacted the federal rebate law in 1992,521 it did not prohibit use of the rule for transactions with terms up to sixty-one months, so it is still necessary to know how to calculate a Rule of 78s rebate. Fortunately, as you may recall from high school, if you know the formula, you can get the right answer even if you do not know how the formula was derived.522 So, herewith, the formula:

Consumer Credit Regulation: 5.8.7.3.3 The explanation of the Rule of 78s for those who care (optional reading for the practitioner)

So how does the Rule of 78s work? Like the pro rata method, the Rule of 78s calculates the fraction or percentage of the finance charge that has been earned at any point in the loan. Unlike the pro rata method, however, the Rule of 78s does not assume that the interest earned in each month (or other interval) of the loan is equal. Instead, it weights the earliest months in the loan term most heavily and attributes progressively less interest to later months.

Consumer Credit Regulation: 5.8.7.4.1 Legal status

The most accurate and the fairest way to balance creditor and debtor interests in a rebate calculation is to determine the actuarial interest that the creditor has earned at the time of prepayment and to refund to the borrower the difference between the total contract interest and this actuarially earned amount. Generally accepted accounting principles consider this the economic reality.541

Consumer Credit Regulation: 5.8.7.4.2 Calculation of actuarial rebates

The computation of an actuarial rebate requires the construction of an amortization schedule. There is no easy formula to calculate the rebate. At the time each payment is made from the beginning of the loan to the point of prepayment, the interest earned during the preceding period or fractional period must be computed by multiplying the outstanding principal balance by the periodic interest rate, and the payments received must be used, first to pay off the accrued interest and, second, to reduce the outstanding principal balance.

Consumer Credit Regulation: 5.8.7.4.3 Actuarial rebates under actuarial split rate statutes

A special rebate calculation issue arises under actuarial “split rate” usury statutes, which apply one interest rate to part of the outstanding balance and another rate, to the rest.553 Such statutes do not produce a simple interest amortization pattern. Yet, when calculating rebates for precomputed transactions under actuarial split rate statutes,554 creditors frequently assume simple interest amortization, using one twelfth of the APR as the monthly interest rate.

Consumer Credit Regulation: 5.8.8.1 Failure to Give a Required Rebate As a Usury Violation

A number of decisions recognize that failure to give a required rebate, or to calculate the rebate correctly, gives rise to a usury or overcharge claim557 and entitles the borrower to the remedies the usury law provides.558 As discussed in the next subsection, older decisions holding that a contract cannot be made usurious by a “contingency” have largely been rendered irrelevant to rebate issues by the incorporation of rebate requirements into consumer credit laws.

Consumer Credit Regulation: 5.8.8.3.1 Whether intent is required

Under some consumer credit statutes, specific remedies are authorized wherever finance charges (or simply charges) in excess of those allowed are charged, or more generally where provisions of the act are violated.567 Any time the statute provides for a specific remedy for imposing charges in excess of those allowed, a provision requiring rebates should be considered to be encompassed by that language.

Consumer Credit Regulation: 5.8.8.3.2 Does the contract show the creditor’s intent to charge unearned interest?

There are two ways in which a creditor may violate usury law rebate requirements: either the creditor can provide a contract that on its face fails to provide for the appropriate rebate, or it can neglect in actual practice to give a rebate that it is both contractually and statutorily required to give. Where intent is required, demonstrating a usury violation in the first situation may be considerably easier than in the second because the contract itself can show the creditor’s intent. In many jurisdictions, it is usurious merely to “contract for” usurious payments.

Consumer Credit Regulation: 5.8.8.3.3 Has the creditor failed to give the rebate the contract requires?

If a credit contract properly provides for a rebate upon the early termination of a precomputed debt, the next question is whether, when the prepayment or acceleration finally occurs, the creditor actually gives the rebate properly. Often the issue will be whether the creditor’s acts violate a statutory prohibition against “charging,” “collecting,” or “receiving” usurious interest.579

Mortgage Lending: 8.10 Liability of Other Third Parties

Mortgage transactions may also involve other third parties who can have a significant impact on the borrower’s finances—for good or bad.667 Much of the work these third parties perform will fall within the broad definition of “settlement services” under the Real Estate Settlement Procedures Act (RESPA)’s Regulation X.668 And, consequently, charges for these services will typically be subject to RESPA’s disclosure and anti-kickback rules.669 T

Consumer Credit Regulation: 5.9.1 Overview

Refinancing, in the right circumstances, and with the right lender, is a good deal for both parties. For example, many consumers replaced the 10% to 11% purchase money mortgages written in the 1980s with 7% to 8% mortgages when interest rates dipped to surprising lows in the early 1990s.

Consumer Credit Regulation: 5.9.2 Refinancing, Consolidation, and Flipping Defined

At the outset, it may be helpful to define some of the terms used to describe different kinds of credit renewals. While “refinancing” is seldom statutorily defined, it means to “finance something new,” usually after a renegotiation of credit terms.612 On paper, a “refinancing” is a new loan, generally between an existing creditor and debtor, the proceeds of which are used to pay off the preexisting debt.

Consumer Credit Regulation: 5.9.3 The Elements of the Price Escalator

In assessing a series of refinancings, it is useful to keep both a micro and macro viewpoint. Illegal overcharges can occur even if the transaction as a whole does not breach standards of ethical dealing. Conversely, the creditor’s dealings may well violate community standards even if no specific illegal overcharge was imposed. This subsection discusses the charges to evaluate for scrutiny in a series of refinancings. But do so keeping in mind the true value the consumer received out of the transactions.

Consumer Credit Regulation: 5.9.4 Small Loan Example

Here is an example of how it works.624 A Pennsylvania consumer made a retail purchase for $747 on a “90-day same as cash” basis. The seller assigned the paper to a finance company, a common introduction to finance company borrowing. Over the course of the next six years, the consumer received approximately $6,000 from eleven separate advances, each of which was accomplished through a refinancing. Each of the advances was a small sum, less than $1,000.

Consumer Credit Regulation: 5.9.5.2 Compounding

The calculations in a refinancing transaction should be checked to see whether, in determining the payoff on the prior loan, the lender improperly compounded interest. One of the reasons it is so expensive for borrowers to bring delinquent accounts current via refinancing is that earned, but unpaid, interest from the delinquent account is added to the principal in the new account, thus swelling the basis upon which interest on the new account is calculated.