Don’t Get Sucked into New Loan Options – The Truth Behind Loan Costs

Banks & businesses are in the business of making money.  Period.  They provide a service or a product for a fee – when you borrow they charge you interest for using their money.  If you always keep that point in mind when you are borrowing money or buying on credit it can save you thousands of dollars over the life of a loan. Part of learning to manage your money better, is learning how to use credit wisely.

understanding loan costs

Watch Out For Costly ‘Extras’ and ‘Freebies’

I am going to give you an extreme example to make my point.  It’s not unusual for a finance company to charge 30-32% percent interest on their loans.  Believe it or not, that’s not the worst part.  In most cases, they sell their customers “loan insurance” for many thousands of dollars (up to a quarter of the face value of the loan) which they add to the loan at the outset.  If you borrow $10,000 from this company it is not uncommon to end up repaying $18,000 or more over the life of a relatively short loan.

No major bank does anything like this, but it serves to illustrate just how much interest and service charges can increase the cost of borrowing.

If a loan has some fancy feature or clause you can bet there is a fee associated with it.  If you are getting “cashback” at the outset then you need to realize you will be paying interest on that cash until the loan is repaid in full.

Think as well about getting something ‘free’ as part of your plan. Cell phones are a typical example of this. Cell phone subsidies are really just a loan in disguise. What is really happening is you are being sold a phone and the purchase price is rolled into the cost of the plan, with profit and inherent interest. The day I looked this up you could get a Samsung Galaxy Note 3 for $199.99 on a two year plan OR pay $699.99 up front.  Do you really think they haven’t set the pricing to recover the $500 difference? Now it’s really hard to tell the difference exactly since the ‘plans’ they offer change based on the choices you make (month-to-month or contract) but a quick check showed I could get a month-to-month plan for as cheap as $45 while the contract minimum price (you know with the free phone) was $70 a month.  Guess what, that’s a $600 difference over 2 years. Guess I paid for the phone after all, plus interest.

No money down, don’t pay a cent events are the same. The lending cost of letting you take something home before you pay for it is buried in the price, guaranteed, plus the processing fee is really just another form of interest in hiding. Shop around for a cash deal, you might do better. If you do opt for the take it home, and pay later approach make sure you pay your bill on time. If you don’t you will probably be charged interest back-dated to the date of purchase.

Find the Best Provider

Generally speaking, banks are the best place to borrow, if you have to borrow.  Finance companies charge astronomical interest and have some of the highest fees as well.  Credit cards should be used as a payment convenience, not a borrowing option.  Lines of credit are better than credit card but with a line of credit you might never pay off the debt. Any time you are borrowing from a store, you are likely paying very high interest and / or subsidizing the interest through a higher purchase price.

When to Say No

A final word of caution – if you apply for a bank loan and you aren’t approved then you should take that as a pretty good indication your finances are not in order.  Banks make money by lending people money.  If the bank doesn’t think you can afford to repay the loan then they are probably right.  Heed the bank’s warning. Don’t be desperate enough to try more expensive lending options that could make your finances that much worse. Instead, find someone to review your financial situation and help you develop a plan to take control of your money.

Category: Debt Management | Tagged in:

Mar 12, 2014

About Ted Michalos

Ted is a Licensed Insolvency Trustee and Chartered Accountant with more than 20 years experience. He is a co-founder of Hoyes, Michalos & Associates Inc., one of the largest personal insolvency practices in Canada focused on helping individuals deal with their debt.

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