Interest calculations on small and medium credit agreements

[Riebens]

I am a software developer and develope software for clients .. not always knowing the specific subject matter as well as the clients.

I have a few client that uses our loan managment software to manage their car dealerships (written specially for them at heir request and instructions). They purchase cars and resell them taking a deposit and self finance the rest of the balance.

Up to now, they used to specify a fixed yearly interest rate, and amortize it monthly over the repayment period.

Now they come with a request for daily interest calculations, and I can see where this comes from, if the customer paid extra capital on his loan or failed to make payment, that must reflect on the interest - either positive or negative - immediately.

My understanding is that the yearly EAR compounded monthly is then actually supposed to be less than the EAR compounded daily ? Morally - Is this not just another way to get extra money from the consumer that is already in debt?

Another issue ... people with debit order deductions .... how do I cater for the monthly variances when they have signed a debit order instruction? Are we allowed to adjust the amount?

IF I do monthly compounding for instance 12 % I get an APR of 1 + (0.12/12)12 for a 28 day month and for a 31 day month which works out nicely for a fixed debit order amount every month, while on a daily compounding I get for instance 1 + (.12/365) 28 and 1 + (.12/365)30 and 1 + (.12/365)31 which is not the same.

Any comments on this is appreciated as i am not a financial guru, and neither are my clients and I don't want to give them something which is not good for them or their clients.

[Dave A]

On monthly vs daily calculations - you should stick to monthly calculations when instalments are paid monthly otherwise, as you say, it gets messy.

Daily calculations should only be applied on variations, and you'd typically offset this from the last regular transaction.

IF I do monthly compounding for instance 12 % I get an APR of 1 + (0.12/12)12 for a 28 day month and for a 31 day month which works out nicely for a fixed debit order amount every month, while on a daily compounding I get for instance 1 + (.12/365) 28 and 1 + (.12/365)30 and 1 + (.12/365)31 which is not the same.

I think you've got a problem with the calculation you're using. The advertised rate needs to be the annual effective rate of interest, so unfortunately determining the monthly rate for compound interest is not as simple as "annual rate / 12".

[Riebens]

Thanks for the feedback, unfortunately I don't have the luxury of saying if the calculations needs to be monthly or daily.

I understand the difference between nominal and effective interest rates. In my example it should have been EPR instead of APR ... my mistake.

an nominal rate of 12% works out to an effective rate of about 12.34%

Kind Regards

Ben

[Dave A]

unfortunately I don't have the luxury of saying if the calculations needs to be monthly or daily.

Perhaps in that case make sure the client is well aware of the calculation methodology applied and signs off on it. Better still, ask them to provide it.

I'd think the main concern is if the effective rate is misrepresented in the contract there'd be repercussions - and you wouldn't want the fingers of blame turning in your direction.

I've attached an excel spreadsheet that converts effective to nominal and vice versa - just set the interest rate and number per annum.


If you've got an effective rate to meet, then convert it to the nominal rate and then you can divide that by the number of calculation periods per annum.

Or here's the relationship formula -

[Riebens]

great .. thanks ....

Hope I cajn return a favour some day.