Loan Repayment defines paying the borrowed amount back to the lender including the principal, interest rate, all the fees such as broker fees, rebates, discounts, etc. Loan Repayment is one of the critical stages of the credit decision cycle and entails decisions relating to document preparation and execution, constant due diligence of the customers, setting repayment mandate with accurate Annual Percentage Rate (APR) calculations. And, explainability and transparency are of utmost importance at this stage.
End-to-end decision automation will not only allow lenders to comprehend, analyze, model, and automate decisions across the cycle, but offer a clear picture of the process and each decision of loan repayment and achieve business outcomes.
Let’s understand APR calculation, one of the key elements of loan repayment, and how to model an APR calculator.
Annual Percentage Rate (APR) represents the annual interest rate charged to borrowers or earned by the lenders. This is the final number to give to a customer to show how much they are repaying annually. These rates can be different depending on the lender and the borrowers can compare the rates to choose a lender. Therefore, the customers go for the lenders with the lowest APR as this percentage indicates the total extra repayment amount making APR calculation a crucial factor in a loan.
This APR value must be disclosed by the lending financial institutes before a borrower signs an agreement. However, the lenders have the freedom to add charges to be included in the APR.
The basic calculation consists of these steps:
- Calculate the interest rate.
- Add the charges and fees to the interest amount.
- Divide by the principal amount and the number of periods of the loan.
- Multiply the final value by one year and 100 to get the annual percentage.
Now let’s see how these steps can be implemented.
There are different formulas each lender uses to calculate APR. In this example, the following formula was used.
APR = (Fees+ Interest) x 1 year x 100 / Principal and number of periods for the loan
We used FlexRule Decision Management Suite to implement this formula.
First, we define the attributes that require to calculate the APR value as a Fact Concept. These values can be changed depending on the formula you use.
Then define the calculation step-by-step in a Boxed Expression document as formulas. As you can see in the below image, the “Calculate APR” formula contains the “Interest Plus Free” formula. In the same way, you can see how each formula is built.
This ensures the transparency of the formula solving the lenders’ problems related to the APR calculation. You can clearly see how each value was determined, and which attribute was used.
Tackling Lenders’ Challenges through a Transparent APR Calculation
Lenders may face different challenges in calculating APR.
- Different lending types
There are different lending types such as mortgages, credit cards. Certain parts of these calculations and rates can be varied.
- Different complex APR types
There are different APR types within each loan type. For example, a credit card may have four APRs: Introductory/promotional APR, Regular APR, Cash advance APR, Penalty APR. Each of them offers a different rate depending on the customer.
- Changes of Government Regulation
The government regulations and the financial institution laws can be changed from time to time. For example, as Irwin Mitchell reports, the UK government made significant changes to the Consumer Credit Act 1974 (CCA) on 1 February 2011 which affected APR calculation.
However, making the calculation transparent can solve the above problems and challenges as follows:
- Have a better understanding of each step in the formulas.
- Reuse the steps in multiple formulas.
- If there are constant values, it can be changed easily.
- Easy to change the formulas.
- Improve accuracy.
- Business users with no technical background can understand the steps as each step is defined in simple English.
Every step in the loan repayment process is important as it represents how much a borrower pays back at the end. This amount can determine a loss or a profit, making it critical to calculating it accurately in a timely manner. Furthermore, over time circumstances can be changed and affect loan repayment making it challenging to both borrowers and lenders. Therefore, end-to-end decision automation can give accurate end results making the process transparent and maintainable, making the lenders’ job easier, as well as the customers satisfied.
Published February 4th, 2021 at 03:31 pm