The loan contract
In 2005 Dennis and Brenda and their son Stuart borrowed $10,000 from a finance company to purchase a vehicle. The total amount to repay was $19,500 including mechanical breakdown insurance, interest, and broker, legal, and administration fees.
The loan refinances
The loan payments fell into arrears in 2005. The finance company refinanced the loan in June and September 2006, May and September 2007 and in April 2008. The finance company rebated the interest already paid and refinanced Dennis Brenda and Stuart onto a new loan agreement each time, which cleared the arrears balances. The interest on the new loan amount was added at the beginning of the loan balance on each occasion.
In July 2008 the finance company again refinanced the loan, however, this time, the interest was not charged at the beginning of the loan but was charged at 25% per annum and applied to the loan balance weekly. The finance company changed the way interest was charged from July 2008 because the new Credit Contracts and Consumer Finance Act 2003 (“the CCCFA”) required it to make these amendments.
The loan payments again fell into arrears. The finance company refinanced and cleared the arrears on the loan five more times between April 2009 and June 2013. Each of these refinances resulted in a $100 fee being added to the loan balance.
Stuart had stopped paying the loan some years ago and it fell to Dennis and Brenda to pay. The finance company offered to crystallise the debt at $2,600 and accept 52 consecutive payments of $50 to pay the balance. Crystallisation would have meant that no more interest would be charged and the balance of the debt could never be any higher than $2,600.
Dennis and Brenda did not accept the finance company’s offer and complained to FSCL. They were of the view that they had already paid enough towards the loan and questioned whether the finance company had charged interest correctly. Dennis and Brenda wanted the finance company to write off the balance of the debt as it was in September 2013 ($2,778.91).
Was interest applied correctly?
We reviewed the loan contract and statements and concluded that interest had been applied correctly. The original loan had interest applied as a lump sum at the beginning of the contract. Each time the loan was refinanced prior to the refinance in July 2008, a rebate of interest already paid was credited to the loan account.
The rebate amount was calculated using the ‘Rule of 78’ which is a formula set out in section 23 of the Hire Purchase Act 1971 which was the legislation which applied to credit contracts before the CCCFA came into force.
The Rule of 78 states that if there is to be a rebate, the finance company had to calculate the portion of each regular payment which paid the interest and not the loan principal. We considered that the finance company had applied the Rule of 78 correctly. Further, when the finance company changed its method of charging interest in July 2008 (that is, it charged interest daily and applied this every 7 days), Brenda and David were in a better position. This was because if the interest was applied in a lump sum at the beginning of that refinance, when they then defaulted on payments, the balance of the loan would have been much higher, and in turn, default interest being applied to the loan would have been higher.
Lastly, when the finance company refinanced the loan again five more times from April 2009 to June 2013, the finance company gave up its right to charge default interest on the arrears, because each time the arrears were written off.
Our CEO considered the offer to crystallise the debt at $2,600 was a reasonable one, but that letter fees of $220 should be credited to the loan balance. This was because there were some shortcomings in the finance company’s service in relation to contacting Brenda and Stuart about the debt.
Although it was a matter for the finance company’s commercial judgment, the CEO recommended the parties enter into a suitable arrangement for Brenda and Stuart to repay the debt at $2,380.
After the CEO’s preliminary view was issued Brenda and Stuart offered to make a lump sum payment towards the loan. With our assistance, an agreement was reached whereby the finance company would accept a lump sum payment of $1,500 to fully repay the loan. With a family member’s help, Brenda and Stuart were able to raise funds of $1,500, bringing the complaint to a final resolution.
Lesson to be learned
Not paying a loan back at the agreed weekly amounts can have significant consequences, especially when there are long periods of non-payment with interest and default interest continuing to accrue.
If you are struggling to pay back a loan, the earlier you seek assistance the better. Your first point of call could be to visit your local budget adviser. It is best to do this before you begin to get into serious financial hardship. Your budget adviser may be able to assist you in negotiating a reduced payment arrangement with your finance company.