Overview

Interest is a fundamental mechanism through which lenders monetize their lending programs. It plays a crucial role in determining the profitability of lending activities and is a key aspect of the borrower lifecycle. Understanding how interest works within the context of a lending program is essential for both lenders and borrowers. In Canopy, the policies governing interest are explicitly defined and can be encoded into the product construct or specified per borrower.

Interest generation in Canopy is influenced by several factors, including the lender's product construct, risk model of the lending program, market served, and the operational model of the lender. Lenders must consider these factors when defining interest policies and calculation methods. Canopy offers various customization options, allowing lenders to tailor interest calculation to their specific business needs.

Account Level vs Line Item Level Interest

Account level interest considers the total balance of the account, while line item level interest allows for more granular interest calculations for individual loans, enabling greater customization and reporting.

Account level interest involves summing up the outstanding principal balance and multiplying it by the applicable periodic rate. The resulting interest amount is added as a line item to the account. This method is straightforward and easy to understand, making it suitable for customers seeking simplicity in interest calculations.

Line item level interest involves calculating separately for each line item using line item level interest generation. It allows for greater granularity and customization in interest calculations. Line item level interest is useful for customers with complex lending structures or those who require detailed tracking and reporting on individual loans within a portfolio.

Interest Computation

There are different calculation methods available within the Canopy system, such as daily accrual, average daily ending balance, interest on the original balance, and interest on the expected balance. These are explicitly defined in your product.

Loan level interest, also known as amortized interest, is generated from a loan. It involves multiplying the outstanding principal balance by the periodic rate to calculate the interest. This interest amount is added as a line item to the account. Amortized interest is commonly used in traditional loan structures for large purchases such as an auto loan or a business loan to finance equipment, inventory, or other business expenses. With respect to amortized interest, the principal and interest payments are spread out over the loan term. This method suits customers who prefer a predictable payment structure. Here are a few variations of loan level interest:

Interest on Actual Balance: Simple installment interest is accrued based on the outstanding principal balance of the loan at the end of each cycle.
Interest on Original Balance: Used for revolving lines of credit, the borrower accrues interest based on a percentage of the original loan balance. The interest may become active after the previous cycle's payment window elapses.
Interest on Expected Balance: This configuration smooths out payment obligations after missed or underpayments. The generated interest is capped at the amount quoted in the initial payment schedule.
Average Daily Ending Balance (ADEB): ADEB interest is calculated based on the average outstanding principal balance of the loan at the end of each day of the cycle, which may result in higher interest charges.
Number of Cycles of Interest: This configuration determines if interest accrual is limited to the loan duration, addressing delinquency scenarios where additional interest may or may not accrue in the final cycles.

Setting Line Item Level Interest Policies

Account Level Interest

API: Create an interest rate record for an account during the given time period

API: Creating an INTEREST Line Item

Account level interest is generated at one or two cadences: daily or at cycle end. Both cadences use the same method for calculating interest. Daily interest generation means scheduling an Interestevent every day at close of business, and will result in more, but smaller, interest line items.

Account level interest at Canopy is created using the line_item_type INTEREST. This differs from amortized interest, which is created using the line_item_type AM_INTEREST.
Inputs for account level interest:
- Account interest rate
  - Stored as APR
- Account interest divisor
  - Used to turn the account interest rate into the periodic rate (the annual interest rate divided by the number of compounding periods)
- Product revolving_interest_applicable_balance_types
  - This denotes which line_item_types are summed to find the interest applicable balance
- Product interest_calc_balance_type
  - This denotes whether to use the ending balance of the cycle, i.e. the principal_cents of line items as of the effective_at of the INTEREST event, or to use the average daily ending balance (the mean principal_cents of line items as of the end of each day in the cycle)
- Line items on the account
  - The principal_cents value is the outstanding balance on each line item. We sum the principal_cents values of applicable line items to find the total interest applicable balance.

Line item level interest

Creating Interest Policies

Input Parameters:

Loan or Account Interest Rate: The interest rate associated with the loan, typically stored as an annual percentage rate (APR).
Account Interest Divisor or Cycle Length: The divisor used to convert the annual interest rate into the periodic rate. For example, if the cycle length is in days, the periodic rate is calculated as (APR * Number of days in the cycle) / Number of days in a year.
Product Configuration: The loan management system considers the product-specific settings, such as the applicable balance types and interest calculation balance type.
Line Items on the Loan: The system takes into account other line items associated with the loan, such as amortized fees or deferred interest, when calculating the loan level interest.

Interest Accrual Timing

This is also known as interest charge timing. Apart from the interest calculation methods, it's important to consider interest timing. Two common options are statement time and daily accrual. Statement time interest calculation calculates interest based on the balance at the statement date, while daily accrual calculates interest based on the daily outstanding balance. Choosing the appropriate timing method depends on your business requirements and the level of precision desired. Here are a few takeaways for how the Canopy system calculates interest timing:

Interest Generation Events
Interest calculations are triggered by specific events, such as the INTEREST or AM_INTEREST event, which are automatically scheduled by the system based on product and account configurations.

Statement Time Generation
In most cases, interest is generated at statement time. Statements have an inclusive start time and an exclusive end time. When interest is generated at statement time, its effective_at value is set to one millisecond prior to the statement's start time. However, there is an exception for "BEGINNING" installment interest accrual, which is generated at statement time with an effective_at value set to the statement time itself, accrued for the new cycle.

Daily Accrual
Alternatively, interest can be generated on a daily basis through daily accrual. In this case, interest is calculated and assigned an effective_at value that is one millisecond prior to the timing of the interest generation event, which occurs daily.

Deferred interest

Deferred interest refers to the postponement of interest payments on a loan for a specific period. If the loan balance is fully paid off before the end of this period, no interest is charged. However, if the loan is not fully paid off within the deferred interest period, interest charges start accruing. Deferred interest is designed to incentivize borrowers to repay their loans within a shorter timeframe. This solution can be beneficial for customers who need flexibility in managing their cash flow or expect to repay the loan early.

Here's a summary of how deferred interest is calculated in the Canopy system:

During the promotional period, which is determined by the product configuration, deferred interest is accrued on the account.
If the borrower successfully repays all charges, excluding the accrued deferred interest, within the promotional period, a DI_WAIVER line item is applied during the payment processing.
This waiver offsets the deferred interest indirectly by applying it to the outstanding principal. Ultimately, this brings the account balance to zero.
However, if the borrower fails to fully pay down their balance by the end of the promotional period, the deferred interest is converted into amortized deferred interest through the roll-up-loan process.
The amortized deferred interest balance is then divided into equal parts, typically based on the number of cycles in the post-promotional period or the loan term.
The amortized deferred interest is expected to be repaid in equal portions throughout the remaining life of the loan.
Amortized deferred interest behaves similarly to amortized fees in terms of repayment structure.