During the last three decades along the sometimes “bumpy road” of Real Estate we have juggled many balls in many different segments of the Real Estate Industry including Real Estate Exchanging, Owner/Broker of a Franchise Operation, Consulting, Developing, Loan Brokering Mortgage Banking and Creative Finance. We have created private mortgage pools and at one time were administering three Limited Partnerships and two LLC’s as investment firms. However, since 1984 we have specialized in the Collection and Servicing of Seller and Privately Financed Notes and Trust Deeds.
Hopefully, some of the lessons learned and situations experienced primarily in the area of Loan and Note Collection and Trust Deed Servicing will be of benefit to Note Brokers and shed some light on the idiosyncrasy involved in the collection of notes. While our background and experience is primarily in California, we have found through servicing throughout the entire country other states have similar statutes and laws relating to this subject.
Whether you are “doing the collection and disbursements yourself” by using the old fashioned “payment book” provided by a Title Company at closing, amortization schedules, the back of your hand or servicing software, it is incumbent upon us as professionals to work within the guidelines set forth in the statutes relating to the treatment of principle, interest and late fees received.
So, before we get into the subject of “late fees” let’s begin with some interesting POINTS OF INTEREST we visited along our career highway.
First, when collecting payments on a note and deed of trust you must be sure to accurately follow the terms spelled out in the note.
If the note calls for periodic payments, that is each month on a specific date the payment is to be made, then that is how the collection must be handled. If the note calls for interest to be collected until the date received, then that is how the note collection must be handled. The beneficiary does not have the option to change how payments are calculated, the note controls this.
Interest on a real estate loan is typically calculated on a periodic basis. Periodic means each payment has its own maturity date according to an amortization schedule.
|For example, if payments are due on the first day of each month, interest is only due from the first of the previous month to the first of the current month (30 days), regardless of when the payment is made. In the situation where the payment is made on the 10th, interest is still only due and calculated to the first of the month.|
In addition to the periodic basis, real estate loans are sometime calculated on a simple interest basis or compounding basis.
Simple interest is defined to mean interest is calculated for the actual period of time the principal is in use. If the payment is insufficient to cover the interest due, a separate unpaid interest balance is maintained and that unpaid interest would have to be paid before any principal reduction would occur. This unpaid interest is non-interest bearing.
|For example, if payments are due on the first day of each month but the payment is made on the tenth, interest is calculated from the first of the previous month until the tenth (40 days). The next month when a payment is made, interest is calculated from the 10th of the previous month until the date the next payment is made.|
Compounded interest is defined to mean that each month the interest is added to the principal and begins to earn interest as principal. When a payment is made, it reduces the principal balance.
|For example, if payments are due on the first day of each month but the payment is made on the tenth, interest is calculated from the first of the previous month until the tenth (40 days) and added to the principal. If the payment is insufficient to reduce the balance to amount below the previous balance, the interest added to the account bears interest. The next month when a payment is made, interest is calculated from the 10th of the previous month until the date the next payment is made.|
Whenever a promissory note is absent as to the method in which interest is calculated it is presumed to be periodic. If you wish to use simple interest it must be stated in the note. If you wish to use compounded interest, pursuant to the footnote in California Civil Code Section 1916.1 it must be clearly stated in the note.
Which method is best? Clearly, compounded interest gives the maximum yield but may confuse Payors (borrowers) and they may be resentful (in the initial structuring of a note) by the advantage you gain. Simple interest gives a higher yield that is directly related to the time the borrower uses the principal. Simple interest may be somewhat confusing to the consumer but should not cause any resentment. Periodic is most favorable to the consumer. Your own policy decision should dictate which is best for you, if you have the luxury of actually creating or recasting of a note.
ANOTHER TIP – COUNT THE MIDNIGHTS!
Here’s a tip, I learned from my good friend David Perreria. ” When calculating the days for interest, count the midnights”. This will avoid calculating interest for too many days. You must also consider whether interest should be calculated on 360-day year or on a.3365-day year. When calculating interest, it is expressed as an annual rate and amount and then divided by the day period. A 360-day year will have a higher per day figure than a 365-day year.
If you use a 360-day year, every month has 30 days, even months with 28, such as February, and 31, such as January. In the case wherein the borrower is tendering a full payoff on the 28th of February, interest is calculated for an additional two days to the 30th even though a 29th and 30th do not exist in February. However, in the month of January, if a payoff is tendered on January 31st, interest is still only calculated to the 30th and no interest is calculated for the 31st.
If you use a 365-day year, interest is calculated for the actual days in the month. However, when calculating payments on a periodic basis, each month has 30 days for the amortization schedule but interest is calculated for actual days when doing payoffs or when interest needs to be calculated over actual days.
Just remember, whatever method you use; it is critical you do not mix the two. See Chern v. Bank of America 5 Cal. App. 3d 866. In the B of A case, the daily rate was calculated on a 360-day year, resulting in a higher daily rate, but the actual number of days interest was counted was using a 365-day. This resulted in a slightly higher yield to B of A but the court determined it was unlawful. If you are structuring the note, it is best to have the supporting documentation to reflect the calculation basis.