This PROM Tech Letter addresses the various types of fees that are typically charged on consumer loans and discusses how these fees are disclosed.  This discussion of fees does not include credit insurance, property insurance, or vendor single interest premiums.

Fees can generally be separated into three categories.

1. Filing Fees. The first category is fees paid to others (public officials) on behalf of the borrower usually to pay for the cost of filing, continuation, and discharge of documents, as well as to pay any taxes, related to the loan.  These typically are recording fees and similar fees levied by public officials to record deeds, mortgages, title certificates, liens, and so forth.  We will call this category of fees "filing fees."
2. Prepaid Finance Charges. The second category is fees are those retained by the lender (or perhaps paid to a broker for originating the loan) and that are paid at or before the closing of the loan. These fees are generally an additional interest charge paid by the borrower over and above the interest to be charged at the stated interest rate.
   
   These fees can be called any of a number names, and the names frequently are somewhat obscure to conceal that the fee is really an additional interest charge.  Some typical names used are Loan fee, Bank fee, Acquisition fee, Credit Investigation fee, Origination fee, Administration fee -- there are many others.  We will call this category of fees "prepaid finance charges".
3. Other (non-financed) Interest Charges.  The third category of fee is also retained by the lender but is not paid until after the loan is closed (it is paid evenly over the life of the loan). This type of fee has generally been replaced with Prepaid Finance Charges because of the advantage to the lender of collection the fee up front.  We will call this type of fee an "other interest charge" (it could also be called a non-financed interest charge).

In this discussion, "loan amount" refers to the amount the borrower has asked for.  Because of the way fees can be handled, this amount can be different from the proceeds, amount financed and/or note amount.

"Amount financed" refers to the amount to be disclosed as such as defined in the Truth-in-Lending regulation.

"Finance charge" refers to the total finance charge, including interest, any prepaid charges, and/or other interest charges. It is the amount defined as the finance charge in the U.S. Truth-in-Lending regulation.

"Prepaid finance charges" refers to the total of prepaid interest and other charges that are paid by the borrower prior to or at the loan closing (or are added to the loan amount), and are considered prepaid finance charges as defined in the Truth-in-Lending regulation.

"Note amount" refers to the initial principal balance that the borrower must repay.

Filing
Fees

Filing fees can either be added to the loan amount or paid by the borrower at the time of the loan signing.

If they are added to the loan amount, they become part of the note amount and amount financed.  They should appear in the itemization of the amount financed.

If they are paid separately at loan signing by the borrower, they are not part of the note amount or amount financed and would not appear in its itemization.

In either case, the fees paid must be disclosed in the "Fed Box" of the Truth-in-Lending disclosure as "Filing Fees."

Prepaid
Finance
Charges

If an interest charge or other charge that qualifies as a prepaid finance charge is paid by the borrower at or before the time of the loan signing, or is deducted from the note amount, it must be treated as a prepaid finance charge and disclosed accordingly.

Frequently, as a service to the borrower, the lender will increase the loan amount by an amount equivalent to the prepaid finance  charges.  This essentially lends the borrower enough additional money to pay the prepaid interest charge.

This practice is best illustrated through an example.

If a borrower requests a $1000 loan and the bank has a $50 prepaid interest charge which is paid at loan closing, the borrower would receive a net amount of $950 after deducting the $50 prepaid interest charge.

If the lender increases the loan amount to $1050 and then deducts the $50 prepaid interest charge, the borrower receives a net amount of $1000, the amount originally requested.

The loan is actually for $1050 ($1050 is the note amount and is the amount on which the periodic interest charges and payment are based).

Whether or not the borrower increases the loan amount, the $50 prepaid interest charge is a prepaid finance charge and must be disclosed as such.

Note that a prepaid interest charge is always financed (an interest charge is levied upon it) whether or not the lender increases the loan amount by the its amount.

This occurs because the periodic interest rate is applied to the note amount (initial principal balance) and this amount includes the prepaid interest charge.

In the above example, if the borrower receives an amount of $950, the note amount is $1000 and interest is being charged on $1000 ($950 plus the $50 fee). If the borrower receives an amount of $1000, the note amount is $1050 and the interest is being charged on $1050 ($1000 plus the $50 fee).

Thus in either case, an interest charge is being assessed on the fee.

If the borrower elects to pay the $50 fee in cash at loan closing, it still must be disclosed as a prepaid charge.  The Truth-in-Lending Regulation recognizes that the net financial gain of the borrower is only $950 even though the borrower must repay $1000 plus the interest on it.

The Annual Percentage Rate is based on the amount financed of $950 as well as on the higher finance charge (the interest charge plus the $50 prepaid finance charge).

Other
Interest
Charges

In some states, the interest fees are added to the finance charge but not paid at loan signing or deducted from the loan amount. This type of fee is rare, used only in a few states. No interest charge is levied on the interest fee and this reduces the finance charge compared to a prepaid finance charge.

This type of fee is paid over the life of the loan with no interest earned on it.

Effect on the
Annual
Percentage
Rate

Often, people will say "Is the fee in the A.P.R.?" or some similar question. The A.P.R. calculations are based on both the finance charge and the the time value of the money borrowed.

They are based on the amount financed, and the amount and timing of the payments the borrower has agreed to make.

The difference between the sum of the payments and the amount financed is the finance charge (total interest charge) the borrower is paying.

A prepaid finance charge both increases the total interest charge and reduces the amount financed (funds available to the borrower). It will always result in an A.P.R. that is higher than the loan interest rate.

The disclosure problems encountered with consumer loans (as well as other loans) are generally not the A.P.R. calculations, but the proper calculation of the finance charge and amount financed.

Probably the most common disclosure problem is that a fee that is actually an additional interest charge is not disclosed as such. This results in an understated finance charge and, if the fee qualifies as a prepaid finance charge, an overstated amount financed as well.

The A.P.R. calculated using these incorrect values is going to be understated.

To check a loan, first the amount financed, finance charge, and payment schedule must be verified to make sure that they are in agreement. Any fees on the loan must be examined to determine if they are Filing Fees or Prepaid Finance Charges and, if necessary, the finance charge and amount financed adjusted accordingly.

Then, using the correct amount financed and payment schedule, the A.P.R. is calculated.

See PROM's APRChecker products for more information of checking loans.