Can we set a minimum interest amount required for all loans, which would be charged if a customer pays off a loan without accruing the minimum interest amount? If so, can we set up our system to automatically impose that charge?

While minimum interest charges are permitted for many loans, such charges could be considered prepayment penalties, which are prohibited for certain types of loans. Consequently, we do not recommend setting up your loan system to automatically impose this charge on all loans, without distinguishing loan types for which this charge is prohibited.

In general, there are very few limitations on interest charges under Illinois law for both commercial and consumer loans. The Illinois Banking Act permits banks to charge fees, interest and other charges on loans, provided that the bank sets these charges based on its “prudent business judgment and safe and sound operating standards.” Additionally, the Interest Act authorizes a bank to collect interest and charges at any rate agreed on by the bank and the borrower. Consequently, for many loans, you may establish a minimum interest charge, provided that your customers have agreed to the charge in their loan agreements.

However, certain loans are subject to restrictions on prepayment penalties, and these restrictions may apply to a minimum interest charge. For example, prepayment penalties are limited or banned altogether for many types of mortgage loans. The “qualified mortgage” (QM) provisions in Regulation Z strictly limit prepayment penalties for closed-end loans secured by a dwelling. Additionally, prepayment penalties are banned for such loans if they fail to meet the QM test, qualify as “higher-priced,” or have an APR that may increase after consummation. The “high-cost” provisions in Regulation Z and the Illinois High Risk Home Loan Act (HRHLA), which apply to loans secured by a consumer’s principal dwelling, both effectively ban prepayment penalties that can be charged more than 36 months after consummation or exceed 2% of the amount prepaid. Additionally, both Regulation Z and the Illinois HRHLA ban all prepayment penalties for mortgages that are considered “high-cost” or “high risk.”

Both Regulation Z and the Illinois HRHLA define “prepayment penalty” as a charge imposed when a consumer pays “all or part of the transaction’s principal before the date on which the principal is due” or, in the case of an open-end loan, “terminates the open-end credit plan prior to the end of its term.” (In either case, a narrow exception permits lenders to recoup “waived, bona fide third-party” fees that were paid by the lender at closing in certain circumstances.) The Official Interpretations for Regulation Z provide examples of prepayment penalties, including a “minimum finance charge in a simple interest transaction.” In our view, the minimum interest charge that you described meets these definitions of “prepayment penalty” and consequently would be limited by Regulation Z and the Illinois HRHLA, and possibly other laws or regulations that limit or ban prepayment penalties.

For resources related to our guidance, please see:

Illinois Banking Act, 205 ILCS 5/5e (“Notwithstanding the provisions of any other law in connection with extensions of credit,” banks may charge “interest, fees, and other charges . . . subject only to the provisions of subsection (1) of Section 4 of the Interest Act” and the laws applicable to real estate loans, provided that the bank sets fees based on its “prudent business judgment and safe and sound operating standards.”)

Interest Act, 815 ILCS 205/4(1) (“It is lawful for a state bank or a branch of an out-of-state bank . . . to receive or to contract to receive and collect interest and charges at any rate or rates agreed upon by the bank or branch and the borrower. . . .”)

Regulation Z, QM provisions, 12 CFR 1026.43(g) (“(1) A covered transaction must not include a prepayment penalty unless: (i) The prepayment penalty is otherwise permitted by law; and (ii) The transaction: (A) Has an annual percentage rate that cannot increase after consummation; (B) Is a qualified mortgage . . . ; and (C) Is not a higher-priced mortgage loan, as defined in § 1026.35. (2) Limits on prepayment penalties. A prepayment penalty: (i) Must not apply after the three-year period following consummation; and (ii) Must not exceed the following percentages of the amount of the outstanding loan balance prepaid: . . . .”)

Regulation Z, QM provisions, 12 CFR 1026.43(a) (“This section applies to any consumer credit transaction that is secured by a dwelling, as defined in § 1026.2(a)(19), including any real property attached to a dwelling, other than: . . .”)

CFPB Small Entity Compliance Guide, Ability-to-Repay and Qualified Mortgage Rule, page 48 (“4.9 Can I charge prepayment fees on a covered transaction (§ 1026.43(g))? If you wish to include a prepayment penalty option, you may only do so for fixed-rate or step-rate QMs that are not higher-priced and only when applicable law otherwise permits the prepayment penalty.”)

Regulation Z, “high-cost” provisions, 12 CFR 1026.32(d)(6) (“A high-cost mortgage shall not include the following terms: . . . (6) A prepayment penalty, as defined in paragraph (b)(6) of this section.”)

Regulation Z, “high-cost” provisions, 12 CFR 1026.32(a)(1)(iii) (“The requirements of this section apply to a high-cost mortgage, which is any consumer credit transaction that is secured by the consumer’s principal dwelling, other than as provided in paragraph (a)(2) of this section, and in which: . . . (iii) Under the terms of the loan contract or open-end credit agreement, the creditor can charge a prepayment penalty, as defined in paragraph (b)(6) of this section, more than 36 months after consummation or account opening, or prepayment penalties that can exceed, in total, more than 2 percent of the amount prepaid.”)

Regulation Z, “high-cost” provisions, Official Interpretations, Paragraph 32(a)(1)(iii), Comment 1 (This section of Regulation Z “effectively establishes a maximum period during which a prepayment penalty may be imposed, and a maximum prepayment penalty amount that may be imposed, on a closed-end credit transaction or open-end credit plan (other than such a mortgage as described in § 1026.32(a)(2)) secured by a consumer’s principal dwelling.”)

Regulation Z, “high-cost” provisions, 12 CFR 1026.32(b)(6)(i) (“For a closed-end credit transaction, prepayment penalty means a charge imposed for paying all or part of the transaction’s principal before the date on which the principal is due, other than a waived, bona fide third-party charge that the creditor imposes if the consumer prepays all of the transaction’s principal sooner than 36 months after consummation, provided, however, that interest charged consistent with the monthly interest accrual amortization method is not a prepayment penalty for extensions of credit insured by the Federal Housing Administration that are consummated before January 21, 2015.”)

Regulation Z, “high-cost” provisions, 12 CFR 1026.32(b)(6)(ii) (“For an open-end credit plan, prepayment penalty means a charge imposed by the creditor if the consumer terminates the open-end credit plan prior to the end of its term, other than a waived, bona fide third-party charge that the creditor imposes if the consumer terminates the open-end credit plan sooner than 36 months after account opening.”)

Regulation Z, “high-cost” provisions, Official Interpretations, Paragraph 32(b)(6), Comment 1(iii) (“For purposes of § 1026.32(b)(6)(i), the following are examples of prepayment penalties: . . . (iii) A minimum finance charge in a simple interest transaction.”)

Illinois High Risk Home Loan Act, 815 ILCS 137/30 (“A high risk home loan may not contain terms under which a consumer must pay a prepayment penalty for paying all or part of the principal before the date on which the principal is due. . . .”)

Illinois High Risk Home Loan Act, 815 ILCS 137/10 (“‘High risk home loan’ means a consumer credit transaction, other than a reverse mortgage, that is secured by the consumer’s principal dwelling if: . . . (ii) the loan documents permit the creditor to charge or collect prepayment fees or penalties more than 36 months after the transaction closing or such fees exceed, in the aggregate, more than 2% of the amount prepaid, or . . . .”)

Illinois High Risk Home Loan Act, 815 ILCS 137/10 (Defines a prepayment penalty as “(i) for a closed-end credit transaction, a charge imposed for paying all or part of the transaction’s principal before the date on which the principal is due other than a waived, bona fide third-party charge that the creditor imposes if the consumer prepays all of the transaction’s principal sooner than 36 months after consummation and (ii) for an open-end credit plan, a charge imposed by the creditor if the consumer terminates the open-end credit plan prior to the end of its term other than a waived, bona fide third-party charge that the creditor imposes if the consumer terminates the open-end credit plan sooner than 36 months after account opening.”)