## Older Uniform Acts

## Commentary on Cost of Credit Disclosure Act 1998

Page 8 of 9

PART 7 - REGULATIONS AND TRANSITIONAL PROVISIONS

The two sections in this Part are essentially place holders for actual provisions that would vary from jurisdiction to jurisdiction. The extent of the regulation-making powers that would be necessary would depend on how much of what is in the Uniform Act a particular jurisdiction decides to deal with through regulations. It will be noted that in a number of places the Act authorizes regulations dealing with specific matters. All of these enabling provisions could be collected in a provision such as section 50.

SCHEDULE

SCHEDULE

**1 APR for certain mortgage loans**

This section implements Proposal 1.3: "mortgage APR calculation will be subject to the requirements of Section 6 of the Interest Act." Section 6 of the Interest Act is concerned only with disclosure of the interest rate, while the APR accounts for non-interest charges as well as interest. The Committee appears to contemplate that although the mortgage loan APR will account for relevant non-interest charges, it will be calculated using the rules that govern the expression of the interest rate under section 6 of the Interest Act.

Proposal 1.3 appears to assume that all mortgage loans are governed by section 6 of the Interest Act, which is not in fact true. Section 6 applies only to mortgage loans that have certain characteristics.See footnote 1717 Indeed, given the manner in which section 6 has been interpreted by the courts over the years, it could be argued that section 6 does not really apply to many mortgage loans at all. Nevertheless, whether strictly required to do so or not, Canadian mortgage lenders generally disclose the interest rate on standard "blended payment" mortgage loans in the manner contemplated by section 6 of the Interest Act. It is with this in mind that this section focuses on whether the interest rate is in fact disclosed in accordance with section 6 of the Interest Act, rather than whether section 6 actually "applies to" the mortgage.

This section leaves implicit a point that is explicitly stated in section 2(2) for non- mortgage loans. If there are no non-interest finance charges that would have to be accounted for in the APR, the APR is simply the stated annual interest rate.

An earlier draft of this section specified a mathematical formula for calculating a "section 6" APR. However, it was ultimately decided not to specify a formula in this section because a yet-to-be-proclaimed amendment to the Interest Act will replace the existing section 6 with a new section under which the method of calculating interest will be prescribed by regulation.See footnote 1818 It is conceivable that such regulations could change the method of expressing the interest rate under section 6 of the Interest Act, so it was not considered prudent to explicitly specify a formula based on the current section 6.

Suppose that a mortgage loan to which this section applies involves a substantialSee footnote 1919 non- interest finance charge, such as a brokerage fee, which must be accounted for in the APR. Here the APR must actually be calculated because it will be higher than the annual interest rate. How is this done, given the existing wording of section 6 of the Interest Act?

In its existing form, section 6 of the Interest Act requires disclosure of an annual interest rate "calculated yearly or half-yearly, not in advance," and lenders generally base the disclosed rate on "half-yearly" calculation. The following formula could be used to derive an APR based on half-yearly calculation of interest for a loan with virtually any schedule of advances and payments, so long as the amount and timing of all advances and payments was known (or could be assumed) at the time the APR was to be calculated.

General formula for APR based on "half-yearly" calculation

The APR is the value of "r" (expressed as a percentage) that satisfies the equation:See footnote 20 20

sum from {j=1} to {j=m} A_j over {left( 1+{r over 2} right)^{2t_j}}

~=~sum from {k=1} to {k=n} P_k over {left( 1+{r over 2} right) ^{2t_k}}

**where**

j, k is the sequential number of a particular advance (j) or payment (k);

m, n is the total number of advances (m) or payments (n) anticipated by the credit agreement;

Aj, Pk is the amount of advance number j or payment number k;

tj, tk is the time at which advance j or payment k occurs, measured in years (and fractions of years) from the date of the first advance.

Like any APR equation, this equation would be solved through an iterative (trial-and- error) process that starts with a guess at the value of "r" and adjusts the estimated value of "r" up and down until a sufficiently accurate approximation of the APR is reached.

This general equation could be used to determine a "section 6" APR for a mortgage loan with multiple advances and a highly irregular payment schedule (so long as the amount and timing of all advances and payments was known or could be assumed). But the garden-variety residential mortgage tends to be much less complicated, consisting of a single advance followed by a series of equal payments at equal intervals. The general equation can be simplified when calculating the APR for such garden-variety mortgage loans.

**2 APR for other credit agreements**

This section implements Proposal 1.2.

(1) This section would apply to all credit agreements that are not mortgage loans. It would also apply to mortgage loans where the interest rate is not disclosed in accordance with section 6 of the Interest Act.

(2) This subsection implements (with some elaboration) the second sentence of the first paragraph of Proposal 1.2.

The purpose of paragraph (2)(b) is best illustrated through an example of where it would not apply. Suppose that the interest rate on a loan with a three-year term is 2.9% for the first six months and "prime + 3%" thereafter. The relevant prime rate is currently 6.5 %. The effect of section 5(2) of the Schedule is that the interest rate for the last 30 months of the term is assumed, based on the current prime rate of 6.5%. So the interest rate for the last 30 months of the term is assumed to be 9.5%. Therefore, paragraph (2)(b) is not satisfied because the assumed interest rate for the last 30 months of the term is different from the interest rate for the first six months.

Paragraph (2)(c) would be satisfied where the stated annual rate is based on a compounding period that matches the payment periods. It would not be satisfied where, for example, the borrower must pay interest monthly but interest is compounded daily, and the stated annual interest rate is the daily rate multiplied by 365. In such a case the

calculated APR would be higher than the stated annual interest rate.See footnote 21 21

(3) The formula in this subsection appears to be different from the formula set out in Proposal 1.2. However, when the definitions of terms and calculation rules set out in this subsection and in Proposal 1.2 are taken into account, they are mathematically equivalent to each otherSee footnote 2222 (and to the APR calculation procedures specified by existing provincial legislation). The algorithm in this subsection is more straightforward than the algorithm outlined in Proposal 1.2 because the former dispenses with the latter's concept of the "average principal outstanding" during the term. Employing the concept of average principal merely adds redundant steps to the calculation of the APR.See footnote 2323

When a credit agreement requires a borrower to pay non-interest finance charges, the total cost of credit will comprise two components: (1) interest; and (2) non-interest charges.See footnote 24 24 However, the APR is calculated by pretending that the cost of credit consists entirely of interest. The APR for the actual credit agreement equals the annual interest rate on this hypothetical "interest-only" loan.See footnote 25 25 For an interest-only loan, the sum of the interest that accrues during each calculation period ( smallsum `r`L_{x}`P_{x} ) will equal the total cost of credit (i.e., C, which is defined as total payments - total advances). The objective is to find the annual interest rate for the hypothetical interest-only loan that satisfies this equality. This is accomplished by an iterative process in which the estimated value of r is adjusted up and down until a suitably accurate approximation of the APR is derived.

The formula and calculation rules set out in this subsection comprise what the U.S. Regulation Z refers to as the United States Rule Method. Regulation Z allows credit grantors to calculate the APR for closed-end credit using either the actuarial method or the U.S. Rule method.See footnote 2626 The actuarial method assumes that interest is compounded at intervals determined by the frequency of payments, whereas the "U.S. Rule produces no compounding of interest in that any unpaid accrued interest is accumulated separately and is not added to principal."See footnote 2727 As noted in the commentary on Regulation Z,See footnote 2828 the U.S. Rule and actuarial methods produce identical APRs where all payments occur at regular intervals (e.g., monthly). They may differ slightly where the payment schedule has irregularities, such as skipped payments.See footnote 29 29

**3 Rebates**

This section implements Proposal 1.6. It addresses a situation where a consumer is given an option of getting a cash rebate or a low interest rate. Subtracting the foregone rebate from the cash price decreases the amount that is considered to have been advanced to the borrower for the purpose of calculating the APR and total cost of credit. This will have the effect of increasing the APR and total cost of credit that is disclosed to the borrower.

**4 APR for leases**

(1) This reflects the formula set out in section 38 of the DHA's drafting template proposal ( Proposal 13.2), with a couple of stylistic adjustments and corrections to defined terms.See footnote 30 30 Firstly, the variables in the CCDA equation are all represented by a single letter: P instead of "PMT" and so on. Secondly, C (the capitalized amount) appears by itself on the left side of the equation in the CCDA, whereas the DHA equation has "PMT" (the periodic payment) on the left side of the equation. The terms of the CCDA equation can easily be rearranged so that P is alone on the left side of the equation, as in the DHA drafting template proposal:

P~=~{C~-~R`(1+i)^{-n}} over {{{1`-`(1+i)^{x-n}}

over i}~+~x}

One advantage of arranging the terms of the equation as they are in the CCDA, rather than as they are arranged in the template proposal, is that the CCDA's form of the equation can readily be restated in words. It can be read as stating that the capitalized amount equals the present value of all periodic payments plus the present value of the assumed residual payment.

Traditionally, in contrast to what happens under instalment loans, the periodic payments for leases are made at the beginning, rather than the end, of each payment period. For example, for a 24 month lease the first periodic payment would be made at the beginning of month 1 and the last would be made at the beginning of month 24. For a lease where precisely one periodic payment is made at or before the beginning of the term, x would be equal to 1, and the equation in subsection 1 would simplify to either of the following:

alignl C~=~P left[{1~-~P(1+i)^{1-n}} over i ~+1 right]~+~R over {(1+i)^n}#

phantom {x}#

alignl C~=~P(1+i){1~-~P(1+i)^{-n}} over i ~+~R over {(1+i)^n}

Although leases traditionally call for payments to be made at the beginning of payment periods, there is no reason in principle why a lease might not call for payments to be made at the end of payment periods. In such a case, since none of the periodic payments would be made at or before the beginning of the term, the value of x would be 0 and the equation in subsection (1) could be simplified to:

C~=~P{1~-~(1+i)^{-n}} over i ~ +~ R over {(1+i)^n}

Suppose that a 24 month lease calls for the periodic payments to be made at the beginning of each month and also calls for the last two months' payments to be made at the beginning of the term. Since three periodic payments are paid at or before the beginning of the lease term, the value of x is 3. Apart from its effect on the value of x, prepayment of the payments for one or more end-of-term payment periods does not complicate the APR calcuation.

(2) This subsection requires the lessor to be consistent in its treatment of taxes. If an amount in respect of a tax is treated as an advance in determining the capitalized amount, any subsequent payment in respect of that tax must be factored into the APR and implicit finance charge. For example, the GST component of periodic lease payments would be ignored in calculating the APR and implicit finance charge, because an amount in respect of the GST would not have been added to the capitalized amount. However, a tax such as a tire recycling tax or air-conditioning tax might be treated as an advance in calculating the capitalized amount. In that case, any subsequent payments by the lessee in respect of such a tax would be taken into account for the purpose of calculating the APR and implicit finance charge.See footnote 3131

Suppose, for example, that a recycling tax is payable to the taxing authority at the time the lease is signed; the lessor is responsible for collecting the tax from the lessee and remitting it to the taxing authority. If the lessor collects the tax from the lessee at the outset, the tax will not affect the implicit finance charge and APR. However, instead of collecting the tax from the lessee up front, the lessor might instead add the tax to the capitalized amount, to be amortized over the term of the lease. Where this is done, the payments in respect of the tax must be accounted for in calculating the implicit finance charge and APR.

(3) The equation in subsection (1) accommodate leases that characterize the periodic payments as being made either at the beginning or the end of payment periods. It also accommodates leases in which the payment for one or more end-of-term payment periods is actually paid at the beginning of the term. A lease might have a payment schedule that has irregularities that would not be accommodated by the equation in subsection (1) without certain adjustments. For example, the lease might require the lessee to pay the first, rather than the last, few months' payments in advance. Instead of attempting to anticipate and provide specifically for this and other possible permutations of lease payment schedules, subsection (3) requires the basic equation to be modified as necessary to ensure that the periodic rate is calculated in accordance with actuarial principles.

(4) Part 5 of the Act applies to leases with indefinite terms. To calculate the APR and implicit finance charge for such a lease, it is necessary to make some assumption about the length of the term. The assumption that is set out in this section is similar to the assumption for demand loans set out in section 5(3) of the Schedule.

**5 Assumptions and tolerances**

(2) For a straightforward floating rate loan, this subsection amounts to a requirement that the APR and other information that depend on the interest rate will be calculated by assuming that the interest rate will not change during the term.

The commentary on section 2(2)(b) of the Schedule gives an example of a more complicated arrangement, where there is a low "teaser rate" for the first part of the term. The example describes a loan with a three-year term under which the interest rate is 2.9% for the first six months and prime plus 3% for the remaining 30 months. The prime rate is 6.5% at the beginning of the term. This subsection requires all relevant calculations to be made on the assumption that the interest rate for the last 30 months of the term will be determined on the basis of the circumstances existing at the time of the calculation. The relevant "circumstance" is that the current prime rate is 6.5%, so all calculations must be made on the assumption that the index value for the last 30 months of the term will be 6.5% and that the interest rate will be 9.5%. The result will be a composite APR that is much closer to 9.5% than to 2.9%.

(3) This subsection would apply, for example, to a demand loan. If a non-interest finance charge is imposed in connection with a demand loan, the charge's effect on the APR will depend on the duration of the loan. All else being equal, the actual effect of a given charge on the APR will diminish as the duration of the loan increases. This subsection adopts the convention, which is fairly common in this sort of legislation, that the outstanding principal will be repaid after one year.

(5) Accuracy to within one eighth of 1 percent is a fairly standard requirement in existing North American cost of credit legislation. It must be said that the U.K. approachSee footnote 32 32 of requiring the APR to be expressed to the nearest decimal place (e.g., 8.9%) seems more in keeping with the usual manner in which interest rates (and APRs) are expressed. However, a credit grantor who adopts the practice of rounding its correctly calculated APRs to the nearest decimal place will ensure that its disclosed APRs are within the permitted tolerance.See footnote 33 33

(6) The assumptions set out in this section are by no means exhaustive of the assumptions that might be useful; hence subsection (6) authorizes regulations that would prescribe additional assumptions. It should also be kept in mind that section 7 of the main part of the Act provides a general authority to make reasonable assumptions about information that is not ascertainable at the time of disclosure.

**6 Calculation of prepayment refund**

This implements Proposal 4.1. For example, if a loan were prepaid 2/3 of the way through the term, 1/3 of any non-interest finance charge imposed at the beginning of the term would have to be refunded to the consumer.

**7 Maximum liability under residual obligation lease**

This implements Proposal 15. It is assumed that the intention of the proposal is to put a cap on the consumer's liability for unanticipated decreases in the lease-end market value of leased goods. Thus, this section does not place any restriction on the amount of the "estimated residual cash payment." It will be recalled from the commentary on the definition of this term in section 37(1) that the estimated residual cash payment represents an amount that the consumer has agreed to pay at the end of the lease term, assuming that the actual lease-end value of the goods equals their anticipated value. The estimated residual cash payment will often be nil.

(1)(2) The following example illustrates the application of subsections (1) and (2). A residual obligation lease for a car provides for monthly lease payments of $600. The estimated residual value is $10,000 and the estimated residual cash payment is $0. Because of unanticipated market conditions at the end of the term, the lessor is only able to sell the car for $7000. Leaving aside the possibility of an appraisal pursuant to regulations under paragraph (b), the realizable value of the leased goods would be the greater of the amounts determined under paragraphs (2)(a), (c) and (d):

(a) $7000 (the price for which the lessor sold the car);

(c) $8,000 (80% of the estimated residual value);

(d) $8,200 ($10,000 minus 3 times the $600 monthly lease payment).

Thus, the realizable value of the goods is deemed to be $8,200 and the lessee's maximum liability, applying the formula in subsection (1) is $1,800.

The possibility of an appraisal to determine the value of the goods is not addressed by Proposal 15. The U.S. Consumer Leasing Act provides consumers with an appraisal right; the lessee has the right to obtain, at his or her own expense, an appraisal from an independent third party agreed to by both parties, and that appraisal is binding.See footnote 3434 Paragraph (2)(b) would allow jurisdictions to provide a similar appraisal right through regulations, should they decide that it is appropriate to do so.

(3) This somewhat convoluted subsection assumes that Proposal 15 intends to cushion consumers from unexpected decreases in the residual value of the goods because of market conditions or other circumstances beyond the consumer's control. Conversely, it assumes that the proposal is not intended to protect consumers from the consequences of their own actions.

To illustrate the operation of this subsection, suppose that the car referred to in the preceding example is worth $7,000, rather than the expected $10,000, not because of unanticipated market conditions or other events beyond the lessee's control, but because of damage caused by the lessee's improper use of the car. In this circumstance, the realizable value would be reduced from $8,200 to $7,000 because the difference in the amounts is attributable to damage for which the lessee is responsible. The result is that the lessee would be liable for the entire difference between the estimated residual value and the actual value.