Kembara’s Financial Solutions - Rates of Interest
It's common for lenders to tack on interest when extending credit. A bank, credit card firm, or even a payday loan provider could be the lender. The manner the interest rate is disclosed may be rather deceptive. Here are a few fictitious instances: Example Tom is searching for a loan to purchase a new laptop and has discovered four different options: 1. The personal loan offered by ABC Bank will include quarterly interest payments and a 10% annual interest rate. 2. XYZ Bank is providing a loan with a 10% annual interest rate that will be added to the debt each month. 3. The monthly interest rate for the MISA credit card is 1%. 4. The Payday Loan Company will tack on 0.8% daily interest. Which source of funding is the least expensive for Tom? The credit card and payday loan lower rates could initially appear more affordable than the 10% quotes from the banks. Even though the payday loan is only quoted at 0.8%, it is very obvious that it is the most expensive because the percentage is a daily rate. It is immediately calculated to be closer to 292% pa (as there are 365 days most years). The MISA credit card appears pricey when compared to the two banks, though not quite as unreasonably so. Since there are 12 months in a year and the banks are both claiming 10%, a monthly fee of 1% can be looked of as around 12% annually. Tom now has to decide between ABC and XYZ, both of which are quoting 10%. However, there is a clear winner in this scenario: ABC bank is less expensive because it adds interest quarterly while XYZ does so monthly. This indicates that the loan balance rises each month at XYZ bank but just once every three months at ABC bank. At XYZ bank, interest is essentially being charged more frequently on interest because interest is charged on the unpaid debt. If Tom takes out a $1,000 loan, the progression of the loan balance in the two banks throughout the first six months is depicted below. Bank ABC The yearly interest rate of 10% divided by the year's four quarters yields a quarterly interest rate of 2.5%, which is added to the loan. Bank XYZ The yearly interest rate of 10% divided by the year's 12 months results in a monthly interest rate of 0.833%, which is added to the loan. Therefore, it is evident from the foregoing that ABC bank is less expensive after six months, with a loan balance of $1,050.625 as opposed to the higher loan level of $1,051.03 at XYZ. Because ABC charges interest less frequently (quarterly as opposed to XYZ's monthly), this is the case. The aforementioned illustration demonstrates how the disclosure of interest may be deceptive if caution is not taken to ensure that all relevant factors are taken into account. Actually, regulatory agencies also assist by mandating that lenders provide rate quotes based on comparable criteria. In most cases, the quoted rate must be made yearly available, and some sort of effective annual rate must also be revealed. The advertised rate is changed to reflect the frequency of interest charges to arrive at the effective annual rate. The stated rate and the actual annual rate are same when interest is charged on a yearly basis. When interest is accrued on a quarterly or monthly basis rather than annually, the effective annual rate will be higher than the rate stated.
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