When taking out a loan, be it a consumer loan or a mortgage, the cost of the loan is one of the main criteria to look at. In a few words, the cost of the credit includes the interest that will be paid when the loan is repaid, as well as the ancillary costs such as application fees if there are any. If the cost of a loan does not include everything, it should be expressed, for example: “excluding the cost of optional insurance”. It is thus a benchmark indicator which allows to decide on the attractiveness or not of the proposed loan offer.
Cost of credit: definition
In concrete terms, the cost of credit corresponds to the difference between the total amount to be reimbursed during the term of the loan and the amount borrowed initially + the potential costs.
The cost of a consumer loan therefore depends on several criteria:
- The amount borrowed
- The repayment period (as well as the repayment frequency: month, quarter, year)
- Interest rate
- Additional costs such as booking fees or optional insurance
The interest rate expressed in the form of APR (annual effective annual rate) in the context of the consumer loan must take into account all the costs inherent directly to the credit, such as administration fees. The costs related to optional insurance are included in the TAEA (effective annual insurance rate).
With these elements, in addition to the cost of credit, it is also possible to calculate the monthly payment, that is to say the amount to be reimbursed at each due date. Our credit comparison is based on the cost of credit excluding optional insurance, c is to say on the APR.
Cost of consumer credit: a benchmark indicator
For us, it is the benchmark indicator because unlike the rate which can take several forms and thus be confusing: TEG, TAEG, TAEA, nominal interest rate, interest-free credit, etc., the cost of credit as to he has only one definition. However, you should be aware that the cost of credit takes into account all the initial costs associated with taking out credit. Indeed, it is common that the cost of insurance which is optional in the case of a consumer credit is not included in the calculation.
The downside of the cost of credit is that it can vary over time depending on the following reasons:
- The interest rate is not fixed: rate revisable in mortgage or rate revisable for revolving credit.
- Partial or total early repayment: following an early repayment, the repayment period is thus modified and shortened and consequently the cost of credit is reduced. Be careful however because prepayment charges may be requested.
- Break in repayment of credit: some organizations offer the borrower the possibility of temporarily stopping (1 or 2 months) the repayment of their monthly payments, several times a year. The monthly payments are thus postponed, but thus the current interest and the cost of the credit thus increases.
- Costs related to late reimbursements.
The cost of credit is not the only criterion of choice
Even if the cost of a loan is a benchmark indicator, it is not the only criterion of choice.
Another data to take into account is the repayment capacity of each. In fact, too high a monthly payment could increase the borrower’s debt ratio and thus penalize the daily management of his budget. The credit organizations also take this information into account and they will refuse to grant the credit if they consider that the monthly payment of the credit generates a debt ratio too high for the borrower.
In general, if the debt ratio exceeds 35% following the addition of the monthly loan payment, the credit request will be refused in this form. One of the solutions if this proves possible is to extend the repayment period in order to reduce the monthly payment and possibly increase the cost of credit. In general, the longer the repayment period, the higher the cost of a loan.
It is therefore essential to compare the APR rates when you want to make a loan, but also to be aware of the cost of the loan and the associated monthly payment. As such, Sir Credit displays this 3 information in order to allow an easier comparison.
On some sites, the cost of credit is replaced by the total amount due which corresponds to the total amount to be reimbursed, i.e. the capital borrowed + the cost of credit.
However, any offer of consumer credit must include at least the APR practiced and the cost of the loan.
Cost of credit: the calculation formula
This is the formula that applies when the monthly payments are fixed over time.
Concrete example :
Or a 10,000 USD credit over 60 months at 5% APR
Monthly payments = 188.71 $ and cost of credit = 1 322.61 $
Good news, if you are not a seasoned mathematician, the tools allowing to calculate the monthly payment or the cost of a credit abound on the web.
Cost of a loan: miscalculations
The law requires any lender to display the cost of consumer credit as well as the APR. For several years, many miscalculations have been identified at first by consumer associations, especially with regard to mortgage loans which do not fit into consumer credit. Companies have made their trade from this error tracking which can prove lucrative in many cases.
The main mistakes regarding home loans are:
- Wrong TEG
- cost of wrong credit
- incomplete information
These errors can be expensive for the bank because each borrower (individual or professional) can thus take legal action in order to even repay part of the interest. The most frequent sanctions are the replacement of the initial interest rate (which can be the cause of the sanction if it is wrong) by a much lower interest rate which is called the legal interest rate.