Financing: Simple Interest Question ????

[Mark099]

Without the benefit of a financial calculator during our Open House visit at SSR, we were trusting that "simple interest" meant "non-compounding". Once home, I was able to run the financing calulations through a computer only to realize that our payment is actually based "monthly compounding interest" calculations.

We purchased a DVC membership at SSR on June 12th. Our DVC host at the Open House specifically said the financing was "simple interest", which meant it did NOT compound making it better than any mortgage. Heck, even the financing documents use the term "simple interest". Now I have all the resources at my disposal and realize that my monthly payment equals the "monthly compounding" payment calculated by my software. This means that I would end up paying at least $2812.80 more in interest charges over a 10 year financing period.

Am I missing something? Does "simple interest" have a different meaning in the U.S. than it does in Canada?

 

[JimC]

You pay interest on the outstanding balance each month. If you pay early the amount of your interest payment decreases. If you pay late the amount of your interest payment increases. Simple interest means with each payment you pay the interest due from the time of the last payment to the current payment on the amount outstanding.

 

[Mark099]

Originally posted by JimC
You pay interest on the outstanding balance each month. If you pay early the amount of your interest payment decreases. If you pay late the amount of your interest payment increases. Simple interest means with each payment you pay the interest due from the time of the last payment to the current payment on the amount outstanding.

Then why say...

the financing was "simple interest", which meant it did NOT compound making it better than any mortgage.

It is clearly NOT better than any other loan that would normally compound semi-annually.

 

[JimC]

I know of no consumer loans that compound semi-annually (twice per year).

Maybe this will help:

Simple interest is calculated as the amount borrowed times the rate times the amount of time outstanding. Simple interest is generally charged for borrowing money for short periods of time. Compound interest is similar but the total amount due at the end of each period is calculated and further interest is charged against both the original principal but also the interest that was earned during that period.

DVC calculates your monthly interest charge by taking the amount outstanding times the periodic interest rate (which is usually the annual rate coverted to a daily rate) times the number of days the amount was outstanding.

Simple interest is the easiest and fairest way of charging for borrowed funds.

 

[Mark099]

Originally posted by JimC
I know of no consumer loans that compound semi-annually (twice per year).

Simple interest is the easiest and fairest way of charging for borrowed funds.

Mortgages and secured loans are compunded semi-annually here in Canada.

Simple interest may be the easiet, but it is still not the fairest. A semi-annual compounded loan still yields a smaller payment and less interest charges.

My main concern is the deceptive practice of using the term "simple interest" in both written and verbal forms -- especially since there is no written definition in the financing contract. The term in the context of our discussions with DVC is very misleading, at best, and fraudulant, at worst, when coupled with the phrase "the interest does not compound".

I think I will contact member services to get their explanation and see if we can arrive on common ground before the 27th of June.

 

[FLYNZ4]

Mark,

Maybe we are talking about differences in US and Canadian banking rules... but the descriptions that others have offered are consistent with what I would consider to be simple interest.

Since this is a US property transaction... it would make sense to follow the US banking policies.

/Jim

 

[JimC]

I believe Jim (FLYNZ4) has hit on it. My comments earlier were based on U.S. application, not Canada.

Clearly if your Canadian mortgages accure interest semi-annually, then there are substantial differences between U.S. and Canadian practice. In cross border transactions, it pays to ensure that you understand the legal conventions of the contract's governing law.

The U.S. has very strict truth in lending laws and Disney's contracts comply with them. Mark099, I think it is a bit unfair to label Disney's practice as you have. It might be better to say that you did not understand the differences between U.S. and Canadian lending practices.

It is probably a good idea to call DVC and ask them to explain it. Tell them you are Canadian and that the contract language would have a different meaning there. I am sure they have CMs who have handled those questions in the past.

 

[Mark099]

So, how are mortgages compounded in the U.S.? They cannot be worse than monthly or are they?

 

[Geoff_M]

The standard in the US on mortgages is monthly compounding.

Out of curiosity, on what document that you have does it say that the interest for DVC financing is "simple interest"?

In the US, federal law requires that each lender give you a "Truth In Lending" statement that details the financing that you are about to enter into. Everything is spelled out in a uniformly prescribed manner. I seriously doubt that DVC is trying anything underhanded in this area. Mortgage lending is a regulated industry in the US, and time shares are very heavily regulated due to some of its shady past here in the US.

Call, the DVC quality assurance department and hash it out with them.

 

[Mark099]

Originally posted by Geoff_M
Out of curiosity, on what document that you have does it say that the interest for DVC financing is "simple interest"?

In the US, federal law requires that each lender give you a "Truth In Lending" statement that details the financing that you are about to enter into. Everything is spelled out in a uniformly prescribed manner. I seriously doubt that DVC is trying anything underhanded in this area. Mortgage lending is a regulated industry in the US, and time shares are very heavily regulated due to some of its shady past here in the US.

It is in the Note and Truth-in-Lending Disclosure Statement on page 2 under...

1. Initial Interest Rate. The unpaid principal balance due hereunder shall bear interest at a simple interest rate of...

 

[wildcatwmn]

is that I want a Canadian mortgage!

 

[pumpkinboy]

Originally posted by wildcatwmn
is that I want a Canadian mortgage!

Maybe you do, maybe you don't. Not sure if it is still the case, but it used to be that Mortgage Interest in Canada is not deductable from you income tax.

 

[Geoff_M]

It is in the Note and Truth-in-Lending Disclosure Statement on page 2 under...

1. Initial Interest Rate. The unpaid principal balance due hereunder shall bear interest at a simple interest rate of...

The more I look at this I think the problem is a difference of definitions. "Simple Interest" means that the interest is calculated against the principal balance due at the time of calculation. Simple interest doesn't speak to the length of the calculation period... be it annual, semi-annual, or monthly.

Examples:

There are two basic types of auto loans: simple interest loans and pre-computed loans. The Rule of 78s can only be applied to pre-computed loans that are paid ahead of schedule. To understand why this is such a lousy deal for consumers, you have to understand how a pre-computed loan works.

With a pre-computed loan, the interest owed over the life of the loan is calculated using a standard amortization table. Once you sign on the dotted line for this type of loan, you're obligated to pay back principal plus the full amount of interest that will accrue over the entire term of the loan.

To sum up, interest on a pre-computed loan is calculated in advance and you're on the hook for every penny of it when you sign.

In contrast, with a simple-interest loan you're charged interest each day based on the balance you owe. So the quicker you pay down your balance the less interest you pay. A simple interest loan with no prepayment penalties rewards customers who pay ahead.

http://www.bankrate.com/brm/news/auto/20010827a.asp

From the U.S. Federal Reserve Bank:

What is Simple Interest?
Simple interest is interest paid only on the "principal" or the amount originally borrowed, and not on the interest owed on the loan.

For example, the simple interest due at the end of three years on a loan of $100 at a 10% annual interest rate is $30 (10% of $100, or $10, for each of the three years). No interest is calculated in the second year on the $10 interest that was due after the first year, and no interest is calculated in the third year on the interest that was due after two years.

What is Compound Interest?
Compound interest is interest calculated, not only on the principal, or the amount originally borrowed, but also on the interest that has accrued, or built up, at the time of the calculation.

http://www.ny.frb.org/education/calc.html#simple

Even though DVC computes mortgage interest on a monthly basis, it still is truely "simple interest" because each month the interest is calculated only against the outstanding principal balance of the loan. You aren't paying any interest on unpaid accured interest or fees or anything else.

 

[Mark099]

After searching the internet, loan sites, calculators, etc... I am convinced that the term "simple interest" is used incorrectly 99% of the time when it comes to loans.

I am still not convinced that "simple interest" is an appropriate term for DVC to use in both written and verbal communications. They should be required to disclose what the loan is... a monthly compounded rate loan.

This issue will likely not affect our decision to remain DVC members. However, I plan on pointing out to QA that the discussions about financing charges are misleading and can be easily misinterpreted by those remotely familiar with the differences between simple and compounding interest.

 

[Geoff_M]

They should be required to disclose what the loan is... a monthly compounded rate loan.

I beg to differ, but interest on DVC mortgages doesn't "compound" monthly, it is "accured" monthly based on the principal balance at that time. "Compounding" means you'd be paying interest on interest (this idea is best displayed in things like bank savings accounts where periodic interest payments are added to the account balance and then used to increase the amount of future interest payments).

Your monthly DVC payment has two components: 1) The interest due that month computed by taking 1/12th of the annual percentage rate times the outstanding principal balance, 2) an amount that reduces the principal such that at the end of the loan period the principal balance is zero.

The only real difference between simple interest and compounding interest loans is when the accural period and payment periods are different (as in the example on the Fed' web page I posted).

Maybe I'm missing something, but mathematically how is it that you think the that DVC is compounding interest with its mortgages?

 

[Mark099]

Originally posted by Geoff_M
Maybe I'm missing something, but mathematically how is it that you think the that DVC is compounding interest with its mortgages?

Because the monthly payment is the same for both... DVC's "simple interest" payment = everybody's "monthly compounded" rate payment.

 

[Mark099]

Originally posted by Geoff_M
I beg to differ, but interest on DVC mortgages doesn't "compound" monthly, it is "accured" monthly based on the principal balance at that time. "Compounding" means you'd be paying interest on interest (this idea is best displayed in things like bank savings accounts where periodic interest payments are added to the account balance and then used to increase the amount of future interest payments).

Say it however you want, but the result is the EXACT same monthly payment in this case. This has been my point all along. DVC has said one thing and has done another.

The thing I remember the most are the CMs saying the interest doesn't compound. Yet, all the comparisons to other "monthly compounding" loans yield the same result. Therefore, how is the DVC loan different and, most importantly, how is it better and less costly?

 

[ILPHIL]

I work in the finance industry and the term "simple interest" does have a very specific legal meaning here in the US. Many states require all loans written there to be simple interest because it is the fairest method for the consumer. Interest is accrued each month based on the principal balance, interest rate (usually broken down to a daily rate) and the number of days since the previous payment.
If the term has a different meaning in another country DVC still has to follow the Truth in Lending laws of THIS country.
I know this isn't what the OP wanted to hear, but there is nothing illegal or unethical about Disney's contracts and to state that they are is highly unfair. IMHO

 

[Geoff_M]

Say it however you want, but the result is the EXACT same monthly payment in this case. This has been my point all along.

But that's because the amortization table for a simple interest loan and a compound interest loan will look identical as long as the payment is made each time interest is accured (as monthly mortgage payments are).

Let's take an example of a 10 year $10K loan with an APR of 10%. The monthly payment for such a loan would be $132.15
The amortization table for such a loan would be like this

Month 1: Payment of $132.15 is made. $83.33 in interest is due ($10,000 * (10%/12)) and subtracted from the payment. That leaves $48.82 to apply towards the balance. Ending balance is $9,951.18

Month 2: Payment of $132.15 is made. $82.93 in interest is due ($9,951.18 * (10%/12)) and subtracted from the payment. That leaves $49.22 to apply towards the balance. Ending balance is $9,901.96

Month 3: Payment of $132.15 is made. $82.52 in interest is due ($9,901.96 * (10%/12)) and subtracted from the payment. That leaves $49.63 to apply towards the balance. Ending balance is $9,852.32

...

Month 119: Payment of $132.15 is made. $2.18 in interest is due ($261.03 * (10%/12)) and subtracted from the payment. That leaves $129.98 to apply towards the balance. Ending balance is $131.06

Month 120: Payment of $132.15 is made. $1.09 in interest is due ($131.06 * (10%/12)) and subtracted from the payment. That leaves $131.06 to apply towards the balance. Ending balance is $0

This table holds for both types of loan... as long as the payments are made on time. Let's assume that you skip the first payment. Ignoring late fees and other penalties, here's the difference:

Simple Interest Loan
Month 2: Loan Balance: $10,000. Interest due: $166.66 ($83.33 from the previous month + ($10,000 * (10%/12)))

Compound Interest Loan
Month 2: Loan Balance: $10,000. Interest due: $167.36 ($83.33 from the previous month + ($10,083.33 * (10%/12))) The $10,083.33 = the unpaid loan balance plus the unpaid interest that gets compounded.

The $83.33 of unpaid interest from Month 1 gets lumped into the interest calculation for Month 2 and gets "compounded". The result is that you'd have to pay an extra $.70 with your 2nd month's payment in order to get back on the pay-off schedule.

 

[Mark099]

Originally posted by ILPHIL
I know this isn't what the OP wanted to hear, but there is nothing illegal or unethical about Disney's contracts and to state that they are is highly unfair. IMHO

Nope, it's pretty close to what I wanted to hear. Let's see if I got this straight. In the U.S....

1) simple interest loans do NOT compound, they accrue interest, however, since the monthly payment pays off the interest first it effectively compounds (i.e. accrue = compound) because there is less principal reduction
2) when DVC CMs say the interest does NOT compound, that's true because they "accrue", right?
3) if interest doesn't compound, then it must not accrue either

Suffice it to say that the financing documents are "legally" correct, but the DVC CMs are incorrect in the way they describe or define the loan. Does that sound about right?

If not, let's use an example. If I finance $10,000 over 10 yrs at 10.75% my monthly payment would be...

1) $136.34 via DVC's simple interest "accrual" method, and
2) $136.34 via the monthly compounding method

Do those numbers look right? If not, please help me understand further. If so, how is DVC's financing CHEAPER?