Hi,

True, however this topic is to investigate how vendor financiers manage interest only loans. In nearly all cases their funds are either wrapped around an existing loan, or created as a second mortgage to sell deposit finance. In either case the restrictions are different than the banks, and in this topic, do not factor in how they are managed (in terms of collection of payments and handling of arrears).

See my comments below about variable and fixed interest loans. Your statement appears to describe fixed interest only loans, however my concern is about managing variable interest only loans.

There are a number of issues regarding flexibility, such as;

– extra payments – reducing of principal
– arrears – increase of principal
– penalties – possible increase of principal
– changes in interest rates (during the term of the loan – ie variable interest)

It is my view that as long as all the variables are managed, in terms of properly managing the loan in compliance with the law, then that risk is covered, my main concern is ensuring that the likes of the Department of Fair Trading cannot indicate that the lender is not disadvantaging the borrower in anyway. See more about this below…

However extra payments is not the only thing that can alter the principal, it is common practice for extra charges to be applied to the loan balance. If a borrower misses an interest-only loan payment, then they interest, which should have been paid in full is normally applied to the loan balance, which would mean the principal is now larger, which means higher interest charges for every day that balance is larger, which means a larger interest only payment the next month. And if your payments are fixed (ie using EzyDebit, etc) then the borrower with be in arrears next month, etc, etc

On a side note, here’s some more thoughts…

What needs to be defined here is that there is at least 2 types of interest only loans, variable and fixed.

Variable interest only loans are easy to implement, just calculate the interest on the daily balance and compound monthly. Then charge the borrower whatever the interest amount is.

Very easy to calculate, harder to collect. The reason is the borrower never knows in advance what the interest charge will be. Which is why banks have it easy, they just take the necessary funds out of a linked deposit account.

Whereas fixed interest loans, are easier to run via a debit system like EzyDebit or payments via the borrowers’ employers paymaster.

These type of loans usuallly specify a period where the interest rate will be fixed. Ie 1year fixed interest. During that time, the payments are fixed also (loan balance multiplied by annual % divided by number of payments).

The downside for the borrower with these is that they are unable to make extra payments.

If extra payments were to be allowed, then they would be treated almost like a new loan with a new balance – and with some lenders they ensure that extra payments are made in specified lump sums ($1000, $5000, etc). Again, each lump sum payment would mean the balance and new payments are recalculated. And fees may be applied (to cover the cost of recalculating).

With fixed interest only loans, arrears would be handled like the offset account system, the arrears would sit in a separate system with interest compounding. However with such a system, where interest could be calculated to the cent on a daily basis, it would be too easy for the borrower to overpay (to over estimate the outstanding arrears) and as a result trigger a extra payment penalty. For if they were $95.73 in arrears and they paid $100 to “just fix things up”, how does the lender manage the extra $4.27?

How would you accomodate this $4.27 overcharge? Would you credit them and reduce the loan a $120,000 IO loan balance to $119,995.73 and then recalculate the monthly repayments to $999.96 ?

Or credit their savings account with the $4.27, and absorb the $7 (or more) direct debit charge as a cost, or charge the borrower the $7 direct debit fee, take it out of the $4.27 surplus, and end up with a $2.73 debit which ends up being an arrears of $2.73, which then triggers an arrears notice – and the subsequent arrears notice fee…and so on.

It can get quite silly, I admit, but when your dealing the transfer of small amounts. Sometimes the cost of transfer is larger than the amount being transferred itself.

So why bother transferring at all? Because you want to ensure that the Department of Fair Trading always see that you are always managing the funds correctly, and that means you only keep what you are owed, and any benefit to the borrower is maintained, and this means that if they paid just 1c extra, that 1c is helping to reduce their loan balance.

So how does everyone manage their interest only loans? fixed or variable? Do you charge penalties for over payments, or do accept them at all, what about arrears?

Regards
Michael

Hi,

I understand – actually never can happen in a flash – what most media don’t understand is that the credit code offers a lot of options to consumers along with protection.

Which is why even default means the consumer has 30 days to recover it.

Alternatively they can request hardship allowance if in serious trouble (in this case they were on a different payment plan – one they wrote themselves)

And being a wrapper – you have the flexibility to help people whereas mainstream have to stick to policies, which is why in this case there was an effort to fix the loan arrears rather than collect fees first (name one mainstream that would do that!)

So under our laws it would be nigh impossible to “kick someone out” immediately.

Regards
Michael