CLOSE UP: Loans: What’s in the Fine Print?

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CLOSE UP: Loans: What’s in the Fine Print?

Published by sam - 02/10/07 - 02:10:28 am

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Consumer finance companies have been known to make loans on either an add–on or a discount charge basis, each of which increase the borrower’s cost significantly.

Here’s how the add-on rate cheats you: As you pay off a loan, you are gradually reducing the amount of money you have borrowed. Thus, in the first month after you have borrowed $1,000, your interest charge should be ($1,000 x (.01, the monthly percentage rate) = $10. If you made a payment of $93.33 after the first month, you’ve paid $10 in interest and $83.33 of the principal. So, the second month of your loan, you’re not really borrowing $1,000, you’re only borrowing $916.67. The month’s interest, charge on that amount should be finance charges the second month and for each of the remaining 10 months.

Most loans take into account the declining principal owed, and interest charges each month decline accordingly. With those loans, a 12 percent annual interest rate works out to be a 12 percent annual interest rate. A 12 percent add-on rate, adjusted for the declining balance, actually works out to be a 21.46 percent annual interest annual percentage rate (APR)—which reveals the true cost of borrowing—is calculated for the add—on loan. Make sure any add-on rate quotes are converted to the APR rate, as required under the Truth in lending Act.

The discount charge basis works in much the same way. When you borrow the $1,000 for one year at 12 percent, the interest is deducted in advance and you actually receive $880. On this basis, your actual annual percentage rate would be 24.28 percent rather than 12 percent.

When dealing with a consumer finance company, ask for the APR in writing. This can give you legal recourse if the add-on or discount charge basis are used covertly.

Because loan form a stock-broker use your stock as collateral, be sure to find out in advance not only the basis for the interest rate but also the conditions under which your loan can be called in for full payment or your collateral would have to be increased by the addition of cash or stock.

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October 2, 2007 | Loans, Banking |

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