Credit Contracts and Consumer Finance Regulations

This Topic Includes:
Calculation of loss on full-prepayment formulas
Procedure for calculating a reasonable estimate
Formula 1
Formula 2
When formula does not apply
Examples of each formula
Formula regulations - PDF version available
Model disclosure statement regulations - PDF version available
 

Credit Contracts and Consumer Finance Regulations 2004

Note: Please note Formula 2 (Regulation 11) has been revised. The information below describes the new formula. The previous formula released in August 2004, has been deleted from the Regulations.  It is not applicable.

Calculation of loss on full-prepayment formulas

Section 50 of the Credit Contracts and Consumer Finance Act provides debtors with a right to full prepayment of a credit contract.

The amount that a creditor may require a debtor to pay for full prepayment must not exceed the sum of the following:

• The unpaid balance (including fees or interest charges accrued up to the time full prepayment) calculated at the time of full prepayment.
• Fees to cover the administrative costs relating to the prepayment (provided such fees are authorised by the contract).
• And, a charge that does not exceed a reasonable estimate of the creditor’s loss arising from the prepayment.

Procedure for calculating a reasonable estimate of a creditor’s loss arising from full prepayment

The concept of “loss” in this context is based on principles of contractual damages. Thus, “loss” includes the gains a creditor would have made if the contract had run its course and there had not been full prepayment.

Following contract damages principles, the “loss” is mitigated as follows:

• The award is discounted to its present value.
• The creditor must mitigate its loss by reinvesting the amount fully prepaid, ie the creditor must re-lend the money under a subsequent credit contract at its prevailing interest rate. If the prevailing rate is lower than the original rate, the creditor has incurred a loss.

Section 54 provides for regulations to be made prescribing a formula which the creditor may use to calculate its loss. The formula therefore provides a “safe harbour” to the creditor so that it can be sure it has complied with the Act, ie by correctly applying the formula it won’t have exceeded a reasonable estimate of its loss.

Two formulas have been provided

Formula 1

Formula 1 provides a procedure for where a contract has a single fixed interest rate for the entire term of the contract.

The formula is based on the positive difference between the present value of the remaining payments due on the credit contract and the present value of the payments that would be received if the amount fully prepaid is relent for the unexpired portion of the contract at the creditor’s prevailing fixed interest rate.

This formula applies where the contract has an interest rate fixed for the whole term of the contract.

A creditor may calculate a reasonable estimate of its loss with the following formula.

Loss:

= 0 - if interest rates have not reduced

= VFP - unpaid balance if interest rates have reduced

VFP = value of forgone payments

Mathematically, VFP is expressed as follows:

Where:

f = the number of payments to be made per year under the original contract

v = 

i = the annual interest rate currently offered by the creditor on a credit contract of the same type as the original contract, but with a term equal or closest to the unexpired portion of the term of the original contract

n= the number of payments yet to be made

d= the number of days since the last payment due date

p= the amount of each payment payable during the fixed rate contract

Formula 2

Formula 2 provides a procedure for where a contract has a fixed interest rate that applies for a period of the contract but not the whole term (a “fixed interest period”).

This most commonly applies to a long term contract, eg during a 25 year loan it is common for debtors to “fix” the interest rate for periods, eg one year or five years. At the end of the period, the debtor may “re-fix” for a further period at the creditor’s prevailing fixed interest rate, or the loan reverts to a variable interest rate.

This formula applies where a contract is being fully prepaid during a fixed interest period that is less than the term of the contract.

A reasonable estimate of a creditor's loss may be calculated thus:

Loss:

= 0 (if interest rates have not reduced)

= VFP -unpaid balance (if interest rates have reduced)

VFP is expressed as:

Where:

EBEFT is the expected balance at the end of the fixed term, if this is known. If EBEFT is not known, then EBEFT should be determined by a step by step accumulation of the starting loan amount plus interest at the fixed rate, less payments.

f = the number of payments to be made per year during the fixed interest period in which the contract is fully prepaid

i = the annual interest rate currently offered by the creditor on a credit contract of the same type as the original contract, but with a term equal or closest to the unexpired portion of the fixed interest period of the original contract

v =

n = the number of payments yet to be made during the fixed interest period in which the contract is fully prepaid

d = the number of days since the last payment due date

p = is the amount of each payment payable under the fixed rate contract during the fixed interest period in which the contract is fully prepaid

Formulas do not apply in certain circumstances

These formulas do not apply to contracts with unusual features. For instance, payment amounts must be equal during the contract or the fixed interest period.

Formulas must be calculated at the time full prepayment is made by the debtor.

The formula assumes the money can be reinvested at the time of full-prepayment.

Examples

The following examples, illustrate each formula.

Formula 1 example

At the time the contract is taken out the following variables are relevant:

The debtor fully prepays the contract after 6 months and 5 days. The creditor's prevailing interest rate had dropped to 10%. The relevant variables are:

Applying the above formula:

VFP ($3924.23) - unpaid balance ($3865.66) = a reasonable estimate of the creditor's loss ($58.87)

Formula 2 example

At the time the contract is taken out the following variables are relevant:

The debtor fully prepays the contract after 6 months and 5 days. The creditors prevailing fixed interest rate has dropped to 10%.

Applying the above formula:

VFP ($3897.45) - unpaid balance ($3865.66) = a reasonable estimate of the creditor's loss ($31.79).

*applying during the fixed rate period.

PDF version of formula regulations

The full text of the Credit Contracts and Consumer Finance Regulations 2004 (PDF size 91kbs) and Credit Contracts and Consumer Finance Amendment Regulations 2004 (which amended regulations 11 to 17) are available here to download (524KB).  Instructions for obtaining the Adobe Acrobat viewer.

Model disclosure statements regulations

The Act allows you to use model disclosure statements prescribed by regulations. The model disclosure statements represent the Ministry of Consumer Affairs’ interpretation of compliance with the disclosure standards (ie, clarity, conciseness and bringing the information to the debtor’s attention).

The advantage of using a model disclosure statement is that a creditor can be considered to have complied with the disclosure standard required by Section 32. The model disclosure statements are not compulsory and you are free to choose a different form of disclosure. A decision by a creditor not to use a model disclosure statement does not in itself have a bearing on whether the performance standard for disclosure has been met.

You may also choose to adapt a model disclosure statement to suit your particular business, rather than use the model disclosure statement in its entirety. However, if you choose to adapt particular items or clauses from the model disclosure statement, you could not be said to be using the model disclosure statement. If you choose to adapt the model disclosure statement, ensure your adaptation still complies with the disclosure requirements.

PDF version of model form regulations

The full text of the Credit Contracts and Consumer Finance Amendment Regulations 2004 is available here to download in PDF format (524 KB).  Instructions for obtaining the Adobe Acrobat viewer.

A PDF format version of the model disclosure statement forms from the Regulations is also available to download.