“The compounding interest complaint compounds”

In August 2011, Yogesh took out a loan to purchase a vehicle for $11,995. The total amount to pay including all fees and interest, was $29,000.

Part of Yogesh’s weekly $135 payments went towards the lender’s membership benefit for customers. Under the membership benefit the lender arranged and paid for customers’ registration and WOF costs, and a service every six months. Also, if vehicle repairs were required, the costs of these would be met from any funds accumulated in the customer’s membership account.

If the funds accumulated in the customer’s membership account were not required for repair costs, the funds could be put towards the loan balance.

Yogesh cancelled his membership on 1 June 2015, and stopped loan payments in November 2015 because he thought he had paid his debt by then. The lender did not agree the loan had been fully paid, but offered to reduce the balance of Yogesh’s debt to $1,000. Yogesh did not accept the offer.

Yogesh’s complaint

In May 2016, Yogesh complained to FSCL that his lender continued to seek payment from him. Yogesh also complained the lender added amounts to his loan balance for repairs which should have been covered by his membership.

The lender’s view

When the lender and Yogesh discussed the balance of his debt in late 2015, it agreed to reverse a number of fees charged to Yogesh’s account because they had not been documented in writing.

In addition to these credits, the lender credited Yogesh’s balance by $3,908 which was the interest that had accrued on the reversed fees. However, the lender did not agree to write off fees it said Yogesh had to pay (amounting to $788).

There had also been a credit to the balance of $729 in 2015, of leftover accumulated funds in Yogesh’s member account.

However, Yogesh had not made further loan payments and, by June 2016, the lender said the balance was $5,020.

Review

The lender provided a spreadsheet showing the effects of the fee reversals, and the two credits of $729 and $3,908. However, by our calculations, the credit of $3,908 only represented simple interest and did not take into account the effect compounding interest would have had on the balance of Yogesh’s debt.

We considered that Yogesh had to pay the fees of $788 because they related to towing and repossession costs when he was in arrears. In addition, the largest expense (repair to crank pulley at $505.50) was always going to be met by Yogesh because it was incurred after he cancelled his membership.

Lastly, Yogesh had missed payments and reduced his weekly payment amounts at times, and these factors had increased the balance he needed to pay on his loan.

Outcome

By our calculations, at the time Yogesh stopped making payments in November 2015, the balance of his debt was $1,081.60. We suggested and the lender agreed, to freeze the amount for Yogesh to pay at $1,081.60 with him paying the balance over time.

Yogesh agreed to pay this amount at $100 a week and the complaint was resolved.

Key insights

Compounding interest can have a significant effect on the final balance a borrower has to pay. If lenders are reversing fees at any time during the life of a credit contract, it’s important they factor in a reduction representing the compounding interest that would have accrued on the fees before the fee reversal.