EARLY SETTLEMENT UNDER THE CONSUMER CREDIT ACT 1974

NB 

The new rules apply to all agreements, except for those longer than 10 years in length entered into before 31st May 2005. All agreements will be covered by the new rules from 31st May 2010.

The new rules:

The new scheme uses an actuarial rule for costing the value of the loan against the values of the payments at the time of settlement. The formula is:

which works out the rebated amount to settle the loan, as described on the attached Excel spreadsheet but please note that this is work in progress (occasioned by so many colleagues asking me to provide an alternative to the Dualcalc program which the Office of Fair Trading made available.

Download Dualcalc here. I make it available since the OFT has stopped supporting it, following the death of its programmer, Brian Stewart, but can offer no guarantee as to its usefulness.

The old rules:

Firstly, we need to distinguish between the two main types of interest calculation in common use within the credit industry :

·      PRE-COMPUTED INTEREST - where the total amount of interest is known at outset, and is  declared on the agreement, the APR being fixed; hire-purchase and traditional loan agreements are of this form and are known as fixed sum credit agreements

·      PERIOD RATE INTEREST - interest is calculated on the balance outstanding at the end of each period; the APR being variable. The commonest period rate agreements are for credit cards, store cards and budget accounts (known as running-account credit agreements ), but you should also be aware that some fixed sum credit agreements also charge interest on a period rate basis.

EARLY SETTLEMENT

A debtor under a regulated consumer credit agreement, i.e.. for an amount up to £25,000, is entitled to discharge his or her indebtedness at any time (s.94). The debtor may also demand, from the creditor, a statement of his or her liability (s.97).

A settlement rebate is available (s.97) only where the credit is a fixed sum agreement, i.e.. where a single advance of credit was made at the start of the agreement, not where it is running-account credit.

Rebates are given assuming a delay or 'penalty' of

·       2 months (if the agreement is not more than 5 years long) or

·       1 month  (if the agreement is more than 5 years long).

The penalty is designed to compensate creditors for the initial costs of setting up and administering the agreement.

It is not compulsory for a creditor to charge the penalty - the Act merely lays down a maximum level. Settlement will normally take place on the next available repayment date.

CALCULATING THE REBATE

The calculation is not all that easy to explain. Bear in mind that, in any fixed-sum agreement, the proportion of interest used up in the early months is very much greater than in the later months. (If you have experienced an annual repayment mortgage statement from a building society, you will already understand this!)

For many years lenders have used a system called "Rule of 78" to work out rebates. There follows a short explanation of Rule of 78, but please do not worry if you do not understand it. It is enough to recognise that it exists, and to be able to apply its results.

The Rule of 78 is so called because

1 + 2 + 3 + 4 + 5 + 6 + 7 + 8 + 9 + 10 + 11 + 12 = 78.

Its usefulness is demonstrated in the following example, where we use an agreement in which a loan of £100 is repaid by 12 monthly instalments of £10.
We can represent this agreement on a diagram where we show how the total balance outstanding reduces in monthly steps over the full length of the agreement.
Thus, the debtor owes £120 during the first month, then repays £10 and so owes £110 during the second month, and so on.

Balance (£)

120
100
80
60
40
20
0