Opinion ID: 1627996
Heading Depth: 1
Heading Rank: 2

Heading: Spreading of Interest Over the Term of the Contract

Text: Neither of the lower courts based their judgments on the effect of the first year's excessive payments alone. Instead both looked to the whole five-year term of the note. Both tested the contract by comparing the total interest provided for in the note with the maximum amount that could lawfully be charged over the five-year term, using the method employed by this Court in Nevels v. Harris, 129 Tex. 190, 102 S.W.2d 1046 (1937). The lower courts ended up with opposite results only because they used different true principal sums of the note in making their computations. The trial court held that the true principal sum of the note was the stated face amount of $226,388.77. On this amount it held that the rate per annum of 9½% over the five-year period was not usurious because the total yield did not exceed the amount that could have been charged under the maximum legal rate. It found that upon default and acceleration on August 11, 1975, Tanner, as provided in the note, credited pre-paid interest in excess of the amount accrued to reduce the unpaid principal balance due and owing on the note, leaving a remainder of unpaid principal in the sum of $206,778.74. It was for this amount, plus 10% interest after August 11, 1977, and 10% attorney's fees that the trial court rendered judgment for Tanner, to be satisfied only by sale of the land and without any personal liability against Ferguson. The Court of Civil Appeals held that the true principal of the note was $204,881.84, because it erroneously concluded that the $21,506.93 prepayment of interest in reality constituted a portion of the principal which was not to be advanced until it was applied to the loan beginning July 20, 1977. Accordingly, the Court of Civil Appeals deducted the $21,506.93 of prepaid interest from the $226,388.77 stated principal and computed its maximum actual legal rate for the five-year period on the reduced principal sum of $204,881.84. On this reduced principal sum the maximum legal rate of interest payable over the term of the note was figured to be $101,442.67. This compares with its calculation of total interest contracted to be payable on the note as $106,520.42, or a total of $5,077.75 more than the maximum allowed by law. [3] However, in the $106,520.42 figure, the $21,506.93 prepayment was included as interest. Except therefor, the total interest payable on the reduced principal would have been well within the maximum legal rate over the five-year term of the note. It is an obvious error in these calculations to count the $21,506.93 prepayment as both principal and interest. As heretofore indicated, the trial court properly made its spreading calculations and comparisons on the principal sum as stated on the face of the note, treating all prepaid payments as interest when so designated by written agreement of the parties. When so spread and averaged the total rate of interest payable on the face of the note during its term equals precisely 9½% per annum. We have been cited no authority, and have found none, which would support the action of the Court of Civil Appeals in judicially declaring the first year's prepayment of interest to be principal and then deducting it to arrive at a lower true principal sum. If it is proper to judicially declare the prepayment to be something different from what the parties called it in their contract, there is greater support in the evidence for treating it as an additional down payment on the principal and thus reducing both the principal and the total interest in equal amounts. However, as recognized by the Court of Civil Appeals in a subsequent conflicting paragraph of its opinion, [t]he initial payment was called interest and was to be applied as interest.... The intention of the parties concerning amount of interest due and the dates on which it was to be paid is clear. Obviously, it was error to convert the prepaid interest into principal or to apply it to principal in any manner other than as specifically provided in the savings clauses of the note and deed of trust. [4] The Court of Civil Appeals may have fallen into the error of reducing the principal sum by the amount of the prepayment of interest because in Nevels and other cases where fees or commissions were deducted from cash loans, the true amounts of the loans and the notes were reduced accordingly in testing for usury. [5] The amount of cash actually received by the borrower was held to be the true principal. On this point, the facts of the present case are different. The transaction here was not a loan of money from which any fee, commission or interest was withheld from the payor. Rather, it was a sale of real estate in which Ferguson received a deed to ten acres of land in exchange for his cash down payment and the delivery of the promissory note in the sum of $226,388.77. None of the consideration for Ferguson's note was reserved by Tanner or returned by Ferguson to Tanner. Ferguson had at all times the full use and benefit of the ten acres. Ferguson's prepaid interest was received and credited by Tanner as stipulated in the note. It was contrary to the terms of the contract to treat the prepayment of the first year's interest in any other manner than as provided by the note and the deed of trust. We hold that the true principal sum of the note was its stated face amount. If the Court of Civil Appeals had applied its computations and comparisons to the stated principal sum, its result would have been the same as that of the trial court.