What? Interest on Interest?!
The National Credit Act has brought about a number of changes to the legislation governing debt, credit granting and the recovery of outstanding debt in South Africa.
The changes brought about by the National Credit Act have been the subject of many debates across the country and the interpretation of many of the changes has, with time, evolved as our Courts progressively gave judgment in numerous cases relating to the interpretation of the Act.
This article deals with one small component of the Act, namely how to calculate interest on matters on which the National Credit Act is applicable. Historically, many different descriptions were given to the various methods of calculating interests and one often found contracts applying the logic of compound interest while others applied nominal interest. Before we go too far, let us see what the literature tells us . . . below follows a simplified description of various forms of interest:
Nominal interest: Nominal interest is a rate quoted on an annual basis. It is composed of real interest plus inflation. Nominal interest is not something that can be applied to a debtors account in South Africa, as the National Credit Act does not take into account inflation when calculating interest.
Cumulative interest: Cumulative interest assumes that interest will be compounded at every payment date. In the past, most debt recovery specialists and software packages applied the logic of cumulative interest as it calculates interest from the date of one payment to the date of the subsequent payment. Simply put, the process of calculating cumulative interest would involve calculating the number of days between two payments, then calculating the interest on the arrear balance at the time of the first payment for those numbers of days in between the two payments. It would also then involve the compounding of the interest calculated on the date of the second payment. Recently, this process has been prevented by the National Credit Act as the Act prescribes a different method which is in contrast with the process described above.
Interest on interest: Over the years people have often referred to instances that seemed as if interest was calculated on interest and the general perception was that this was prohibited by the National Credit Act. In reality, the National Credit Act does not specifically provide for the prohibition of calculating interest on interest and there is a mere perception that doing so contravenes the Act.
The question: If the National Credit Act was to be interpreted to allow for the capitalisation of interest, at any stage during the lifetime of a debt, and for the further calculation of additional interest on that capitalised amount, it becomes obvious that the National Credit Act then allows the so-called notion of calculating interest on interest. In order to establish whether the National Credit Act supports or prohibits the capitalisation of interest (and in so doing, the calculation on interest on previously calculated interests), one needs to understand the provisions of the National Credit Act as far as the methods of calculating interest goes.
What is the deferred amount? Section 101 of the National Credit Act deals with interest and fees. Chapter 5 of the National Credit Regulations provides that the deferred amount means the amount payable by the debtor with regard to his or her debt relating to a credit agreement. It further provides that this deferred amount is the amount on which interest must be calculated. It further provides that this deferred amount is then reduced by any amounts paid toward the settlement of the debt. In laymen’s terms it simply means that the deferred amount is the amount that the debtor owes and every amount paid towards that debt reduces the balance on an on-going basis.
Chapter 5 also provides that interest may be calculated daily and may be added to the deferred amount monthly. This may be done at the end of the month or on the same day of every month. This section also provides that the interest calculated in this manner may be added to the deferred amount. Therefore, at this stage, we see that the deferred amount is the amount owing less payments towards it plus interest calculated.
Is that it? According to Chapter 5, the deferred amount also includes all the items listed under section 101 of the National Credit Act under the heading cost of credit. These sub-items to be included in the deferred amount, specifically include the following: (b) the initiation fee; (c) the service fee; (d) interest; (e) cost of credit insurance; (f) default administration charges and (g) collection costs.
This means that interest (d above) as well as collection costs (g above) must be included in the deferred amount.
This further simply means that the deferred amount is the balance owing after the deduction of payments made and the addition of the items listed in b to g above (including interest). Once again, in laymen’s terms, this is nothing other than the running balance (as long as the transactions that appear on a debtors statement include only the items listed above). Therefore, interest can be calculated on the running balance of the amount owing by a debtor.
The method of calculating interest: The National Credit Act provides that interest must be calculated on the deferred amount (i.e. the running balance) at the end of every day. Those daily interest amounts then needs to be kept separate from the debtors statement and added to the outstanding balance at the end of every month.
The Rand value of the interest is calculated on the following basis:
The deferred amount (i.e. the running balance) for the day multiplied by the interest rate for the year, divided by the number of days in the year.
That amount must be stored separately and at the end of the month, the amounts due in terms of such interest for every single day calculated must be added together . . . and then added to the deferred amount (i.e. the running balance).
Cumulative interest: We often get caught up in the use of terminology like compound interest or cumulative interest.
As the National Credit Act portrays a general leniency towards debtors, it is assumed that the National Credit Act also prohibits cumulative interest (i.e. charging interest on interest). This assumption is incorrect as the National Credit Act does not refer to any of those methods directly. However, the method prescribed by the National Credit Act is very clear and provides that interest may be capitalised on a monthly basis.
It further also very clearly provides that the next calculation of interest would be done using the deferred amount, which is nothing other than the running balance which already includes previous interest.
And finally: If one therefore wants to make use of laymen’s terms, the National Credit Act does allow for the charging of interest on previously charged interest.
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