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, . . ATTACHMENT Agenda Item 20b March 9, 1994 .'110 < Policy for Dealing With FIP Loans December 16, 1993 2 balance is $105,009, the annual interest due would be $3,150 ( .03 times $105,009 ). So, although the interest rate stays the same, the interest payment declines over the term of the loan. Buy comparing a FIP amortization schedule and a FIR amortization schedule for the same example loan, it is seen that there-is no difference in the total interest and principal received by the CWCB, assuming the loans are paid to maturity. The difference comes when the loans are paid off midterm. The CWCB made FIP Loans through about 1985, at which time all loans were made as FIR loans. FIP loans account for 57 of the 107 outstanding loans, and for 42% of the dollar amount of outstanding loans ( $22 million of the $52 million total.) It is unclear why loans were made as FIP Loans, except that the CWCB staff may not have had easy access to amortization schedules, or the Statutes may not have allowed charging "interest" per se. DISCUSSION FIP Loans are a significant problem for the CWCB for several reasons: 1. These loans understate interest income and overstate principal reduction for approximately the first half of the loan term. Since most of the loans have a 40 year term, and we are less than half way through that term, our reported interest income has been significantly understated. For the example loan attached, the total understatement amounts to $73,000 by the 12th year, which means we are reporting only 66% of the true interest income. For all FIP Loans ( $22 million ), the current understatement in interest income is estimated to be at least $2.4 million. 2. These loans were written to discourage or even eliminate the possibility of prepayment, primarily because principal reduction was being overstated during the first half of the loan term. If this had not been done, the Borrower could have come in and paid off the loan midterm, at great financial advantage. (For the example loan attached, the Borrower could have saved $73,000 in principal repayment, by paying off the loan in year 12.) Prepayment was discouraged by structuring the contract to require repayment of the principal amount, and all interest for the entire term of the loan, regardless of when the loan was paid off. For the example loan attached, the borrowers would have to pay a total of $807,000 in year 12 to payoff the loan, even though the principal balance would be only $542,080 for same loan with FIR accounting. This amounts to a prepayment penalty of $265,000 which is rather outrageous.