An “interest charge” accrues over time and is derived by applying a rate to the unpaid balance under a contract. If these elements are not present, that amount is not an interest charge. It may be a “credit fee”.

The annual interest rate is the periodic interest rate you apply, multiplied by the number of periods in a year. If you charge a daily interest rate, the annual interest rate is the rate multiplied by 365 (not 366, even in a leap year). The annual interest rate must be stated in the contract.

What is a credit fee?

Any charge or fee payable by the debtor is a credit fee if:

it is payable as a condition of the contract, or
it is payable to you in connection with the contract (whether or not as a condition of the contract), or
it is payable for your benefit in connection with the contract (whether or not as a condition of the contract).

However, it is not a credit fee if the charge is an interest charge, a charge for an optional service, a default charge, or a charge imposed by the government.

Examples

You include a charge on every credit contract based on multiplying the advance by 20% (eg, you advance $1,000 and add $200, being $1,000 x 20%, to the unpaid balance). Although this charge is derived by applying a rate to an amount owing, it does not accrue over time. The charge is a credit fee.
You sell goods to a debtor under a credit sale contract specified as “interest-free”. The cash price is $1,500 and the payments add up to $1,750. Although the $250 amount accrues over time, it is not derived by applying a rate. The charge is not interest and is a credit fee.
A debtor obtains credit through a broker. The broker charges the debtor $300 for this service. You pay the broker and add the fee to the unpaid balance. This charge is an advance, being “money paid to the order of the debtor”.
A debtor obtains credit through a broker. On this occasion you are responsible for paying the broker’s charge. You pass on the fee to the debtor. This is a fee payable under the contract to you and is a credit fee.
A debtor obtains credit through a broker. The broker charges $300, which the debtor pays directly. The credit contract makes no reference to it. The fee is payable neither under the contract nor to, or for, your benefit. It is not a credit fee.

What is an establishment fee?

Establishment fees are commonly referred to as application, booking, documentation and commitment fees. The name of the fee is not important but the function of the fee is.

An establishment fee is any fee or charge relating to your costs in connection with:

the credit application
processing and considering the application
documenting the contract
advancing the credit.

It does not have to be a single fee, any fee that has one of the above functions is an establishment fee.

A fee relating to taking security for a credit contract, despite not being specifically mentioned in the definition of establishment fee, would be an establishment fee as it relates to processing an application and documenting a contract.

What is a charge for an optional service?

A charge for an optional service relates to a service that, under the contract, the debtor could choose whether or not to accept.

Example

A consumer credit insurance policy or extended warranty that the debtor did not have to accept to be provided with the credit.

A consumer credit insurance policy that the debtor must accept in order to be provided credit is a credit fee.

What are the rules relating to interest charging?

Interest must not be charged in advance. This means that you cannot require payment of interest, or debit any interest charge, at any time before the end of the day to which the interest charge applies.

There are two limited exceptions:

you can require payment of, or debit, an interest charge in advance if the payment schedule for a contract has a broken first period (a period that is less than the normal period for which interest charges will be debited to the debtor’s account)
you can debit interest on the last day of a multi-day period as long as, when calculating interest, it is not considered part of the unpaid balance on that day.

Example

Interest is calculated daily and debited on the last day of every month. The interest charge for the last day may be debited on the same day, as long as it is not included in the unpaid balance for that day.

Contracts may provide for interest charges to become payable or to be debited at any time after the day to which they apply.

Calculating an interest charge

Section 39 of the Act (Limit on interest charges) provides that interest charges must be calculated using one of two alternative methods:

by multiplying the unpaid balance at the end of the day by the daily interest rate. If there is more than one daily interest rate, the interest rate must be calculated by multiplying each rate to the relevant part of the unpaid balance to which it applies.
by multiplying a weekly, fortnightly, monthly, quarterly or half-yearly interest rate by the whole or part of the average weekly, fortnightly, monthly, quarterly or half-yearly unpaid daily balance to which it applies.

Interest charges for months, quarters and half-years can be calculated on the basis that all months, quarters and half-years are the same length (by simply dividing the annual interest rate by 12, 4 or 2). However, average daily balances must be calculated on the actual number of days in the period.

Examples

The following examples show how the interest charge is determined using the average daily balances method:

Advance: $1000

Payment frequency: monthly

Annual interest rate: 16 %

Whole period – payment made on time:

interest charges cover the month of January, ie, 31 days

unpaid daily balance is $1,000 on each of days 1 to 31

average unpaid daily balance: $1,000 x 31 = $31,000 ÷ 31 [days] = $1,000

interest charges for January: (annual interest rate (16%) ÷ 12) x $1000 =1.33% x $1,000 = $13.30.

Part period – part prepayment made during period:

interest charges cover the month of January, ie, 31 days

extra payment of $250 made during period on 16 January

unpaid daily balance $1,000 on each of days 1 to 15

unpaid daily balance of $750 on each of days 16 to 31

average daily unpaid balance: ($1,000 x 15) + ($750 x 16) = $27,000 ÷ 31 [days] = $870.97

interest charges for January: (annual interest rate16% ÷ 12) x $870.97 = 1.33% x $870.97 = $11.58.

Part period – full prepayment made during period

interest charges cover the first 15 days of January – the loan is repaid in

the unpaid daily balance on each of days 1 to 15 is $1,000

average unpaid daily balance: $1,000 x 15 = $15,000 ÷ 31 [days] = $483.87

interest charges for January: (annual interest rate16% ÷ 12) x $483.87 = 1.33% x $483.87 = $6.43.

What are default interest charges and default fees?

“Default interest charges” are charges that are payable on breach of a contract. The definition of an interest charge is also relevant, so default interest charges must be determined by applying a rate and must accrue over time.

“Default fees” are payable by a debtor if they breach the contract. They include fees payable if you enforce the contract, eg, repossession fees.

Rules for default interest charges

You are not permitted to structure the contract in such a way that the interest rate stated is reduced if the debtor makes the payment on time.

However, the contract may provide for a default interest rate if the higher rate is imposed only where:

there has been a default in payment, and while the default continues, or

a debtor exceeds the credit limit under the contract and while the credit limit is exceeded.

When you apply a default rate, you must make sure it reflects a genuine estimate of the loss caused by the default. A default rate may be struck down if a Court considers it to be oppressive. Oppressive practices may incur Court-imposed penalties.

You should only apply a default rate to the amount in arrears. Applying it to the entire unpaid balance, including amounts not overdue, would exceed a genuine estimate of the loss caused by default and as such would be oppressive.

What are the rules for credit fees?

The Act does not attempt to prescribe the amount or nature of credit fees that may be charged to the debtor. However, a credit fee must not be unreasonable. The Court may annul or reduce a fee that is found to be unreasonable.

When is a fee unreasonable?

The basic rule with all fees is that they must directly relate to costs incurred by you. A fee will be unreasonable if it does not relate to an actual cost you have incurred. Some fees may represent the average cost for specific matters in relation to a class of contracts.

Fees which accrue over time and appear to be in the nature of an interest charge, without meeting the definition of interest (eg, a fee based on the difference between the sum of instalments in a credit sale and the cash price of the goods), are likely to be unreasonable. In such a case it is unlikely they relate to a specific cost incurred by the creditor.

Establishment fees

Establishment fees should be equal to, or less than, your reasonable costs in connection with the credit application, processing and considering the application, documenting the contract and advancing the credit. You could also charge an establishment fee for the average costs of those matters across an appropriate class of credit contract.

Examples

Practices considered unreasonable include:

loading the establishment fee with additional up-front interest charges

increasing the amount of a trade-in allowance while also increasing the establishment fee

charging a fee based on a percentage of the advance, eg, you charge 1% of the amount advanced as an establishment fee. As the cost of establishing the contract does not vary according to the amount advanced, the establishment fee of a high-value loan is likely to be higher than the cost of establishing the contract.

Prepayment fees

Fees or charges on part and full prepayments are considered unreasonable if they exceed a reasonable estimate of your loss arising from the part or full prepayment, including administration costs. See Full prepayment on page x for more information.

Note: You cannot charge a fee representing the average loss arising from a prepayment. Prepayment fees must be specific to the credit contract concerned.

Other credit and default fees

In determining whether a credit or default fee is unreasonable, under Section 44 of the Act (Other credit fees and default fee), the Court must consider whether the fee reasonably compensates you for any costs you incur, or is a reasonable estimate of any loss incurred by you as a result of the debtor’s acts or omissions. The Court also must have regard to reasonable standards of commercial practice.

As with establishment fees, you must ensure that the fees provided relate to the costs incurred. The fee should do no more than compensate you for that cost.

Some fees will not relate directly to your costs, eg, you may pay a brokerage or other third party fee on behalf of a debtor. You should not add a margin to such a fee. However, a separate fee can only be charged if it is no more than the reasonable administrative cost of making the payment to the broker on the debtor’s behalf.

Fees or charges passed on by a creditor

Section 45 (Fees or charges passed on by a creditor) provides that a fee or charge payable by a debtor for an amount payable, or to reimburse an amount paid by you to a third party, must not exceed the actual amount payable by you.

This actual amount must be determined by taking into account any discount, rebate or allowance you receive. For example, if you receive a discount for using a particular lender’s mortgage insurance provider, the amount passed onto the borrower for the insurance must include the discount and not be the full price. Other fees covered by Section 45 include lenders’ mortgage insurance, security registration fees, valuation fees, and fees payable to credit reference agencies.

Fees that would not fall under Section 45 include consumer credit or other insurance or warranty products, brokerage fees when the broker acts as an agent for the debtor, and lawyers fees for services to the debtor. However, Section 44, Other credit fees and default fee, would apply.

This is because such fees are payable by the debtor and are not a fee paid by you to a third party. Also, such fees are normally charges for optional services, which are not credit fees and not subject to the same rules. While Section 45(4) provides that you may receive commissions in connection with consumer credit insurance, this is only for avoiding doubt.

Note: If you charge a single establishment fee that covers the costs of payments to third parties, you do not need to disclose those amounts separately.

Can I charge for my costs in connection with charges paid to third parties?

Yes. If you can quantify the cost to you associated with paying an amount to a third party you can make a reasonable separate charge representing that cost. Provision to make such charges must be included in the contract and disclosed in the initial disclosure statement.

What happens if I debit an interest charge or fee in contravention of the Act?

You may be liable for various penalties that will be outlined in a later publication to be produced by the Commerce Commission. The Court may also order that the charge is reduced or annulled and you will be required to refund the amount improperly charged to the debtor.

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