Interest From Arrears

Interest from arrears decoupling provides a method to separate regular interest from interest on arrears. In this context, interest on arrears specifically refers to the interest that accrues only on missed installments.

Interest from arrears offers lenders a way to specifically identify the interest portion that relates to a loan’s arrears and decouple it from the repayments schedule. This is important because it allows this particular interest to be paid off using a custom payment allocation, which can be tailored to the borrower's affordability.

Terms and definitions

• Late interest: This is the regular interest charged when there are late installment(s) on an account. It is calculated based on the overall outstanding balances and includes the interest on arrears. In this case the interest from arrears portion is tightly coupled with the repayments schedule.
• Interest from arrears: Interest calculated on the overdue installment total due(s) (late installments). If an instalment is not paid, arrears would constitute the missed installment. Arrears interest would be the interest that accrues on this missed payment. For more information, see the following sections.

Interest from arrears calculations

Interest from arrears can be handled in two distinct ways:

• Coupled with the installment: In this scenario, interest from arrears is integrated into the regular late interest calculation. It acts as a detailed breakdown of that late interest, primarily for reporting. This means interest from arrears is paid off whenever the regular late interest is settled.
• Decoupled from the repayment schedule: Here, interest from arrears is entirely separate from the standard repayment schedule. It doesn't affect the loan's active status; the loan remains active even if there's unpaid interest from arrears, provided your regular loan installments are paid on time.

When regular interest is calculated based on outstanding balances (meaning any unpaid amounts), the total interest figure will include interest from arrears. This combined amount is also known as late interest.

Let's look at an example to see how this works:

Loan account setup

• Loan amount = $1000
• Interest rate = 10% per year
• Number of installments = 5
• First installment: March 1st 2022 → not paid
  • Principal amount = $200
  • Interest amount = $8.33
  • Installment state: Late

Interest calculation on April 1st 2022

Since the installment is late, the interest is calculated as follows:

• 10%*1000 (outstanding PB)*30/360 = 8.34
• This amount (8.34) consists of:
  • Regular interest expected (as if the installment had not been late):
    10%*800 (expected PB)*30/360 = 6.67
    As well as:
  • Interest from arrears amount:
    10%*200 (overdue total due) *30/360= 1.67 in interest from arrears
    → 6.67 + 1.67 = 8.34
• We can observe that 6.67 (expected interest) + 1.67 (interest from arrears) = 8.34 interest calculated at outstanding PB).
• We can conclude that interest applied by Mambu on the 1st of April (of 8.34) includes the interest from arrears amount. This is also known in Mambu as late interest.

When interest is applied on April 1st 2022 interest from arrears accrued becomes 0, late interest of 8.34 is moved in the interest balance (including the interest from arrears).

Interest from arrears decoupling

The interest from arrears decoupling mortgage loan method allows lenders to separate regular interest from interest on arrears within their balances, transactions, and accounting records.

With this approach, as seen in the following example, interest from arrears and regular interest will be treated as two distinct entities, each maintaining its own independent balances.

• Interest accrued - for regular interest accrued (regular interest calculated at expected balances, as if installments are paid on time)
• Interest balance - for regular interest applied
• Interest paid - for regular interest paid
• Interest from arrears accrued - for interest from arrears accrued (this balance is present in the normal functionality as well).

These balances are unique to the interest from arrears functionality:

• Interest from arrears balance - for interest from arrears applied
• Interest from arrears paid - for interest from arrears paid.

Interest from arrears formulas

To clarify how these new balances are calculated and how they interact, let's look at the relevant formulas:

Simple interest

Interest from arrears = (Overdue Total Due + Interest from Arrears balance) * Annual Interest Rate/days in year * Number of days late

Compound interest

Interest from arrears = (Overdue Total Due + Interest from Arrears balance) *(((1 + Daily IR)^(Number of days late)-1))

Interest from arrears functionality

Key features of interest from arrears decoupling logic

• Separate from regular repayments: The interest on arrears is kept entirely separate from your loan's standard repayment schedule. This means your regular instalments won't include the interest from arrears portion, and it won't impact the overall repayment plan of your loan.
• Paid via custom repayments: Interest from arrears is paid off through custom repayments, giving lenders flexibility in how it's collected.
• Separate general ledger tracking: Lenders gain the ability to track arrears interest independently within their general ledger (GL) accounts, allowing for clearer financial oversight.

Interest application

• Interest on arrears is applied automatically by the system on the instalment due date, or it can be applied manually if needed.
• The system also recalculates interest on arrears if there are partial payments made towards the outstanding arrears amount.
• While the system does apply interest from arrears, this interest never becomes "due" in a way that would put your loan into arrears. Only unpaid amounts at the schedule level (your regular instalment payments) have the ability to trigger an arrears status for your loan.

Special situations

• Even during a payment holiday (PH), interest on arrears will continue to accrue if there were any late instalments before the holiday period began.
• Additionally, any actions such as a write-off, rescheduling, or refinancing of the loan will also take the accrued interest on arrears into account.
• Interest from arrears must be applied at the time of loan closure so it can either be capitalised (added to the loan balance) or written off. If it isn't applied, it will remain in the accrued balance but will essentially be ignored by the system.

Accrue late interest

The option Accrue late interest works in the following way for mortgage products with interest from arrears:

• Accrue late interest = True: When this option is enabled, your loan account will accrue late interest. This can happen either at the individual instalment level or as a decoupled amount, meaning it's tracked separately.
  • Setting Accrue late interest to true enables the Decouple interest from arrears option.
    • When only Accrue Late Interest is enabled, and Decouple Interest From Arrears is disabled, the interest computation after a late installment takes into consideration the outstanding closing balance. Interest, including interest on arrears amounts, will be allocated on installments.
    • When both the Accrue Late Interest and Decouple Interest From Arrears options are enabled, the interest calculated on arrears amounts will be decoupled from the repayment schedule. At the schedule level, interest will be calculated based on expected Principal Balance.
• Accrue late interest = False: If this option is selected, your loan will not accrue late interest at all, and interest will always be calculated on the expected closing balance regardless if there are late installments on the schedule.