How Much Does the Loan Actually Cost?

When we want to borrow money, we usually do not realize what the term “borrow” actually means. For instance, buying something on credit is actually delaying a payment, or shuddering the payment for a good or service over a period of time. No matter how we see it, in essence, borrowing money to pay for the item at the moment, involves a great deal of cost.

Many shops want to sell items on credit because they have strong links to, if not ownership of, the finance company. They can sometimes afford to sell the items very cheaply and then make their money on the finance deal. With many stores still charging in excess of 25% APR this can mean a very healthy profit for them on items which they sell for barely more than cost price.

APR is the gross amount of compound interest charged if no repayments are made. For example, imagine you borrow £100 from company A and do not pay anything back to them over the course of a year. At the end of the year you still owe them the original £100 plus another amount, let’s say £10, in interest. That £10 indicates that there is an APR of 10% 1.

An APR can be seen as the price of a loan, so that you can compare one with another. At the time of writing this it is possible to obtain a loan from an Internet lender in UK at 5.9%. This means that if you were to borrow £100 you would owe them £105.90 at the end of the year if you didn’t repay anything before then2.

An Example of the situation is as follows:

Mark and Michael both want to get a new computer and they look through the newspaper. Mark looks for advertisements for cheap credit while Michael drools over the specifications of the computers. Mark finds he can get credit at 6% APR. Michael finds just the computer he wants and it’s only £700 with easy credit terms and an interest-free period.They show each other the advertisements they are interested in. Michael’s interest in financial specifications are non-existent and Mark tries to show him otherwise.

Mark and Michael get the same computer and they are very satisfied with them. Mark pays off his low-cost loan over one year on a monthly basis. The total cost of the computer (including credit) is under £740. When the six months is up Michael still hasn’t sorted his finances out and takes the computer company’s credit terms. By the time he has finished paying for it, it has cost him over £1000.