There are rules about how you can calculate and charge a borrower interest or default interest.
Typically under a consumer credit contract, a lender charges a borrower interest for the use of the money. Interest is calculated by applying a rate (generally expressed as a percentage) to the amount a borrower owes under a consumer credit contract.
The Credit Contracts and Consumer Finance Act (CCCF Act) lets you charge interest, but it sets out rules about how you do this and what you need to tell borrowers. This includes rules :
about how you disclose interest charges to borrowers
prohibiting charging interest in advance
about how you calculate interest
about default interest.
What must I disclose?
You must disclose some things about the interest you are charging in the initial disclosure statement that you provide to borrowers before they enter into the loan.
The annual interest rate or rates that apply, as a percentage (for example 5.75% per annum) and how and when each rate will apply.
Any fixed term that applies, for example 9.5% interest fixed for 5 years.
What method you will use to charge interest and how often you will charge it.
How interest is calculated if you are using some sort of benchmark, such as the official cash rate. You must disclose what the benchmark you are using is, what you will charge above (or below) that benchmark and where and when it is published, for example, “interest will be 2.5% above the official cash rate, details of the current official cash rate can be found at www.rbnz.govt.nz”.
The total amount of interest charges (if known and the contract is to be repaid within 7 years).
If there is an interest-free period, how long it is for, and when you will start charging interest.
What default interest charges apply, and how and when these may apply.
You cannot make a borrower pay interest, or deduct any interest charge from a borrower’s account, before the end of the day the interest charge relates to. In other words, you cannot collect the interest before it is earned.
There are only two exceptions to this rule.
You can charge interest in advance if the first payment period is shorter than later payment periods, but this is only allowed for the first repayment.
You can charge interest on the last day of a payment period (for example, the last day of the month) as long as, when the interest is calculated, you do not treat the interest charge as part of the unpaid balance on that day (in other words, you can’t charge interest on interest).
How do I calculate interest?
While the law does not impose a cap on interest rates, it does set out rules about how a lender charges interest. It does this by setting out two alternative methods you can use to calculate the maximum interest you can charge.
Credit law requires lenders to apply an interest rate to the borrower’s unpaid daily balance. The unpaid daily balance is the amount a borrower owes under a contract at the end of the day.
You can specify in the contract when a day ends for the purposes of charging interest. This means you may debit interest from a borrower’s account at 10am if that is the time you specified in the contract as the "day's end".
Can I charge default interest?
Default interest is a different interest charge that a borrower may have to pay if they breach their contract, for example by missing a scheduled payment, making a late payment or not making a full payment.
You must disclose what default interest charges might apply in the initial disclosure statement. You can only charge default interest on the amount that is in default and only for the period that a borrower is in default or is exceeding their credit limit. In addition where a contract is not an on demand facility you cannot call up a loan and charge default interest on the entire unpaid balance.
Default interest charges cannot be recovered if they are a penalty. They must reflect the loss you will suffer and any amounts required to protect your legitimate business interests. The law also allows for a court to reopen a contract that it finds oppressive. This could in some cases include the level of interest charged.
You cannot include an annual interest rate in a contract that increases if a borrower defaults or decreases if a borrower makes payment on time.