While Docutech does not provide any standard construction loan promissory notes, we do have two popular construction notes, Construction ARM Note (Cx8596) and Construction Fixed Note (Cx12875), which contain the following clause:
“Interest on this Note is computed on a 365/360 simple interest basis; that is, by applying the ratio of the annual interest rate over a year of 360 days, multiplied by the outstanding principal balance, multiplied by the actual number of days the principal balance is outstanding.”
Currently, ConformX only supports the “360/360” (“Whole Months”) method of interest calculation. Under Regulation Z, a “creditor may disregard the effects” of certain loan characteristics “in making calculations and disclosures,” including the fact “that months have different numbers of days.” (12 CFR § 1026.17[c]) The Official Staff Commentaries go into further detail, by stating the following:
“Creditors may base their disclosures on calculation tools that assume that all months have an equal number of days, even if their practice is to take account of the variations in months for purposes of collecting interest. For example, a creditor may use a calculation tool based on a 360-day year, when it in fact collects interest by applying a factor of 1/365 of the annual rate to 365 days. This rule does not, however, authorize creditors to ignore, for disclosure purposes, the effects of applying 1/360 of an annual rate to 365 days.” (12 CFR Pt. 1026, Supp. I, Paragraph 17[c] – 1.ii)
Thus, using an “x/360” method to calculate interest, finance charges, the APR, etc. can be used even if a creditor uses an “x/365” method and limiting our calculations to such a method is compliant with Regulation Z.
Nevertheless, there are caveats. The CFPB’s Examination Manual goes into further details about applying a “365/360” method under 12 CFR § 1026.17(c)(3)(iii). At the end of such details, the CFPB notes that “notwithstanding the APR tolerance, a creditor’s disclosure must reflect the terms of the legal obligation between the parties” (CFPB Examination Manual, TILA Module; p. TILA 34). Thus, while a creditor may disregard the effects of actual days in a month under Ibid., “even if their practice is to take account of the variations in months for purposes of collecting interest,” a creditor “shall reflect the terms of the legal obligation between the parties” (Ibid.; see also 12 CFR Pt. 1026, Supp. I, Paragraph 17[c] – 1).
In other words, if the legal obligation (which is “normally presumed to be contained in the note”; Ibid. Paragraph 17[c] – 2) explicitly sets forth the method of interest calculation to be used in the transaction, then such calculation must be factored into the calculations used to determine the interest rate, finance charge, APR, etc. An “x/360” method of calculation may not be used as a substitute.
Because the “360/360” method provides a safer method for calculating the finance charge, APR, etc. – as well as the fact that “365/360” methods are to be used cautiously in Regulation Z calculations, as outlined by Regulation Z and the CFPB’s Examination Manual – we will be removing the clauses referring to this method from Cx8596 and Cx12875, in order to enable the “360/360” method to be applied to loan packages which use these notes, in accordance with 12 CFR § 1026.17(c)(3).
These changes will be in effect on February 22, 2017. If you have any questions or concerns about these changes, please contact Client Support at 1.800.497.3584.