COMPUTING THE APR

1
COMPUTING THE APR

• Walter Witthoff
• and
• Jamie Wolfe

2
The Annual Percentage Rate

• "The annual percentage rate is a measure of the
  cost of credit, expressed as a yearly rate, that
  relates the amount and timing of value received
  by the consumer to the amount and timing of
  payments made. (Regulation Z, Section
  226.22(a)(1))

3
Why Is The "APR" Important?

• Civil liability
• Reviews by regulators

4
What's So Special About Student Loans?

• The interim period is a distinguishing
  characteristic of student loans and greatly
  affects all aspects of disclosure relative to
  Regulation Z, including computation of the APR.
• It is helpful to view the interim and repayment
  intervals as two distinct periods, each having
  unique characteristics and requiring two
  different APR computations and disclosure
  requirements.

5
What do we need to know to compute the Annual
Percentage Rate?

• Terms of the loan
• United States Rule (U.S. Rule) and the Actuarial
  Method
• Federal Calendar
• Unit Period
• Multiple Advance, Single Payment Transactions
• Prepaid Finance Charges

6
United States Rule and the Actuarial Method

• Appendix J of Regulation Z, which is devoted to
  detailed instruction in the art of computing the
  APR, focuses almost solely on the actuarial
  method.
• The U.S. Rule does not require the addition of
  accrued interest to the outstanding balance at
  the end of the unit period, whereas the actuarial
  method does require such capitalization.
• Unique to the U.S. Rule is the fact that
  Regulation Z leaves the definition of unit period
  up to the lender and does not require its use.

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Unit Period

• General Rule. The annual percentage rate shall be
  the nominal annual percentage rate determined by
  the number of unit periods in a year."
  (Regulation Z, appendix J (b)(1))
• "The unit period shall be that common period
  that occurs most frequently in the transaction."
  (Regulation Z, appendix J (b)(4)) As an example,
  on a loan with monthly payments and no interim
  period the unit period would be monthly.
• Time intervals Advances and payments.

8
The Federal Calendar

• Relevant only to actuarial method
• Attempt to standardize measuring unit periods
  under actuarial method
• Equal periods

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Actual Day and Equal Month Computation

• Under the U.S. Rule the decision whether to use a
  360-day (equal month, or 1/12th of a year) or a
  365-day (actual day) year is left to the
  discretion of the creditor.
• With certain exceptions, the actuarial method
  under the Federal Calendar (Regulation Z,
  appendix J (b)(5)(ii)), requires an equal month
  computation.

10
Prepaid Finance Charges (Guarantee or Origination
Fees)

• Generally these fees are deducted from the loan
  proceeds, or occasionally may be assessed at the
  point monthly installments commence. For purposes
  of Regulation Z, such fees are considered prepaid
  finance charges.
• The creditor must factor any prepaid finance
  charge into the calculation of the APR .

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Tolerances

• Regulation Z, Section 226.2(a)(1)(2)
• Regular transactions. The APR must be no more
  than 1/8th of one percent above or below the true
  APR.
• Irregular transactions (e.g., student loans with
  interim periods). The APR must be no more than
  1/4th of one percent above or below the true APR.

12
State Law and APR

• Reconciling the Federal Calendar (APR) and state
  law (application of rate of interest) computation
  methods
• 360 v.365 days
• Compounding of interest