When is a payment not a payment? When is a transaction that is not called a payment, actually a payment? These are questions that come up due to confusion that some loan servicing system users have with the naming conventions used in some of the standard transaction codes.
Blackboard_Loan_Servicing_Definitions.jpgLet’s start with some definitions (in context with the loan servicing world).
Receivable: A transaction code which generates an item on the payments due tab. It has an amount and a due date, and will drive the aging and past due status of the loan. All receivable transactions are satisfied by a specific kind of payment transaction.
Payment: A transaction which pays and thereby satisfies a receivable, removing that receivable from existence. For example, if I have a receivable of $100 principal due, it will go away if I make a $100 Principal Payment.
Reduction: A payment transaction which is not applied toward, and does not satisfy, a receivable. A payment of principal when there is no principal due is a Principal Reduction. This is still a payment in the sense that it records the receipt of cash to the general ledger. A reduction should never be used to reduce a loan balance in a situation where the transaction that is really happening is an adjustment or a write-off. Any time the main payment function of NLS is used and the distribution (or distribution overrides by the user) result in monies being applied in the “unbilled” column, some kind of reduction (depending on the specific balance in question) will be the result.
Write-off: A transaction used to reduce a loan balance when money DID NOT come in from the borrower. Generally this is used to reflect debt that has been determined to be uncollectable. On the General Ledger, the loan balance is credited and the debit either goes to the Allowance For Loan Losses, or to a Bad Debt Expense (depending upon if you expense anticipated loan losses ahead of time as banks are required to do).
Adjustment: An adjustment transaction is generally a custom transaction code, and it differs from a write-off in its reason for existence and possibly in the way it affects the GL. Unlike a write-off which represents money that is owed but uncollected, an adjustment represents a transaction used to fix a loan balance that has been determined to be incorrect. It may not even affect the GL at all (if the ledgers are in balance but the loan balance is wrong, then this transaction might be designed to bring the two into line). The ultimate setup of an adjustment transaction will depend on the reason why there is a problem with the balances and is handled on a case by case basis. Adjustments to interest are a standard function (not a custom trans code) which make changes directly to the amount accrued.
So, what is the bottom line? If you decide for whatever reason that the balance of a loan is higher than it should be, don’t use the reduction transaction (principal reduction or interest reduction) to bring it down, as this reflects a payment. Even though there is another set of transactions called Principal Payment and Interest Payment, the Reduction is still a payment (it just doesn’t affect the status of outstanding receivables) and that Reduction tells the loan system that money came in from the borrower. In this case, use write-offs or adjustments as appropriate for the situation.