What is the “cost of a loan”?
When you take out a loan, you first have in mind the amount you need. 3,000, 5,000 or 10,000 $ for a consumer loan? 150,000, 200,000, 300,000 $ for a property purchase? But this sum is not the only one to have in mind. It is in fact supplemented by fees and interest at a rate fixed by your bank. The whole will be divided into monthly payments to be reimbursed.
If the principle seems simple, the reality is actually much more complicated. Between simple and compound interest, administration fees and insurance, calculating the cost of a loan requires taking into account many parameters and carefully reading your contract. A loan ultimately costs you much more than the amount borrowed.
How does the interest rate on your credit work?
The primary source of fees for your credit is its nominal interest rate. This is an amount listed on your loan contract. This can work in several different ways, which will have to be specified during the first negotiations.
Fixed or variable rate?
The first parameter to take into account in your calculations is the quality of the rate applied. Is it fixed or variable?
- If it is fixed, it will remain the same throughout the contract.
- If it is variable, it will evolve according to a reference index which will have to be defined (inflation, evolution of inter-bank borrowing rates, etc.). If you take out a long-term loan, a fixed rate will often be preferable, but you can choose to speculate on the variation of the interest rate if it is likely to fall in the years to come.
- If it is mixed, it will have a fixed component and a variable component.
The method of repayment of interest may also be different and be made by monthly payment or in arrears, that is to say in one installment at the end of the annual period.
What are the fees to add to your credit interest?
Taking out a loan does not only generate interest, you will have to pay additional costs.
Application and related costs
You will generally have to pay administration fees, excluding specific offers. These are negotiable and are established on a lump sum basis or according to a percentage of the capital determined in the contract. To these will be added additional costs incurred by the bank, tax stamps, registration fees, etc.
Death and disability insurance
With your contract, you will take out death and disability insurance. An offer will be offered to you by your bank but you can call on another insurer to reduce your costs. However, the guarantees offered must be equivalent. The rate applied may be a percentage of the loan or be a function of the amount borrowed ($ 5 in increments of $ 1,000 per year, for example).
You can also take out job loss insurance, in which case you will have to add these costs to the total cost of your loan.
Certain other fees may be added to the total cost of your loan depending on the guarantees required by your bank.
- In the event of a mortgage, you will incur notary fees.
- You may also be asked for a deposit and incur costs.
- The terms of early repayment may be negotiated or even deleted. In case of credit balance before the term, you will have to settle them, which will decrease your possible capital gain within the framework of a real estate purchase.
- If you use a broker to select your loan, you will sometimes pay brokerage fees.
The annual percentage rate of loan (APR) as a reference
All these costs, added to the interest rate (calculated on an actuarial basis, depending on the repayment terms), constitute the annual effective annual rate of the loan (APR). Fixed costs are thus divided by the duration of the credit and calculated as a percentage even if they are settled at once. This makes it possible to calculate the true cost price of the loan and to compare the offers with each other despite the different payment methods.
This is a calculation that should not be overlooked; simply assessing the offers according to their interest rate is not enough to establish a reliable comparison. A low interest rate can indeed hide prohibitive prepayment terms or high filing fees.