The Cost of Credit

The Cost of Credit

How much does credit really cost?

Within New Brunswick, lenders are required by law (the Cost of Credit Disclosure Act) to clearly disclose the true cost of borrowing as well as your rights and responsibilities in their credit contracts.

When entering into a credit contract many of us assume that because we’ve been approved we can afford the credit that has been extended to us. This is not always the case. It is important to be sure that you understand how much it will cost you to borrow and how long it will take you to pay it back.  You also want to make sure that your payments fit into your budget.

Have a plan to pay off the credit before you use it. Before signing your credit contract be sure to look for and understand the following:

Principal/Credit Limit

The amount of money you are borrowing.  If you are buying something on credit this is the total price of the product minus any down payment or trade-in.  If a trade-in was given make sure your contract includes the value and description of the good taken.

Annual Interest Rate
This is the interest rate that you are being charged to borrow money. If you borrowed $100 at an interest rate of %10 it will cost you $10 a year to borrow the money.  Keep in mind that this may only be a portion of the total cost of credit.

Non-Interest Finance Charges

These are charges that a lender may charge in addition to interest.

Amortization PeriodThis is the amount of time it will take you to pay off your loan in full, assuming that your payments and interest rate stay the same and you don’t miss any payments.  

Amortization periods apply to mortgages and other forms of credit like vehicle financing. However, they are increasingly being used when financing vehicle purchases. A longer amortization period reduces the monthly payment but extends the time it will take you to pay off the loan (and increases the amount of total amount will pay). Be sure to consider if it is worth the extra cost in interest you will have to pay by taking longer to pay off the loan.

If you are buying a product on credit take a minute to consider the life span of the product you are buying. Will your payments last longer than the product itself?  Will the interest and costs associated with paying on credit cause you to pay far more than the product is worth in the long run?  

Remember, the amortization period is not necessarily the same length of time as the term.

TermThis is the period of time your interest rate will be in effect. The term and amortization period are not always the same length of time. If your term is shorter than your amortization period you will be required to refinance the balance of your loan at the end of the term.

If you buy a product on credit, your interest rate may go up if you refinance, and there is no guarantee that you will qualify for refinancing at the end of the term. If you are unable to secure financing the product that you purchased may be repossessed.

Annual Percentage Rate (APR)The APR represents the total annual cost of borrowing. It takes into consideration both the interest rate and any non-interest finance charges that you may have paid to borrow. Be sure that you are comparing APR rates, and not just interest rates when shopping around for financing options. A lower interest rate does not necessarily mean it is a better deal if the non-interest finance charges are high. Comparing the APR between two lenders allows you to compare apples to apples.

Total Cost of CreditThe total cost of credit is the difference between using credit and using cash or forgoing the credit altogether. This number gives you a clear picture of how much borrowing will cost you, assuming that you have made all of your payments on time and haven’t paid early.

The total cost of credit can help you to determine whether or not it is worth it to buy on credit, or wait to save up for your purchase. Most of us won’t be able to pay in full when purchasing a home or a vehicle but may be able to save up for purchases such as furniture, home appliances, and electronics.

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