What hides behind a 0% interest consumer loan?

2019 August 12

What hides behind a 0% interest consumer loan?

You’re probably familiar with the phrase “If something is too good to be true, it probably is.” Yet, too many people still fall for the 0% interest rate.. Let's face it, after all, 0% interest on credit really sounds too good to be true. So how does it work?

0% interest -  a marketing trick

'Free' or '0%' are typical phrases used to attract attention. However, the truth is that companies offering 0% annual interest usually charge other fees that increase the total cost of credit. Couple of such fees are contract and monthly admin fees. These seemingly low fees are usually expressed as 0.75% and 0.99% a month and really don't look threatening. Until they are multiplied by 12 months and the situation changes dramatically.

A number of our clients mentioned an attractive 0% interest rate offered by other companies. After comparing the total amount to be repaid for such credit, we noticed that companies offering a 0% interest rate usually end up being more expensive. 

Annual interest rate is not the most important indicator considering the cost of credit

This may sound counter-intuitive, but comparing terms of various loans reveals that the annual interest rate is not the main indicator of the final cost of a loan. The most important indicator to consider is the total annual percentage rate of charge, also known as APRC.

There’s a simple reason why. The cost of a consumer credit consists of several different fees: annual interest rate, contract fee and monthly administrative fee. All together they are expressed as APRC.

Here's a simple example. Let's imagine that we are considering taking a loan from one of two different companies. We want to borrow €3 000 for a period of 30 months.

 

Loan Company A:

Fixed annual interest rate - 0%

Processing fee - 0%

Monthly administrative fee - 0.75%

 

Loan Company B:

Fixed annual interest rate - 9%

Processing fee - 1%

Monthly administrative fee - €5

 

At first glance, the terms offered by Company A seem to be much better than those offered by Company B. After all, 0% interest rate and 0% processing fee are far better than 9% and 1%, right?

However, it turns out that 0% can end up being more than 9%!

 

Loan Company A:

APRC - 17.57%

Monthly payment - €122.5

The total amount to be repaid €3 675

 

Loan Company B:

APRC - 16.18%

Monthly payment - €117.04

The total amount to be repaid €3 601.2

 

Difference between the interest rate and the monthly admin fee

Why is Company’s A loan more expensive in the example above? 

Company A charges a monthly fee of 0.75%. Loan A is charged at 0.75% x 12 = 9% per annum. Therefore, both companies take 9% each. The key difference is that Company A calculates a monthly admin fee of 0.75%. This fee remains the same for the duration of the loan, no matter how much of the loan you have paid back already. And Company’s B annual interest rate of 9% is calculated based on the value of the outstanding loan, which decreases every month.

Therefore, it is often better to pay a higher interest rate than a percentage of a total loan amount as an admin fee. Unlike interest rate that decreases every month, the admin fee remains the same throughout the loan period. 

Transparency and honesty

Each company chooses its own pricing strategy and there is nothing wrong with that. However, transparency is a choice. Companies that value honesty and transparency do not choose to mislead and deceive their customers. 

We have recently changed our pricing. After launching online consumer loans we have decided to get rid of the contract fee. It used to be 3% of a consumer loan amount.

After waiving the contract fee, we slightly increased the monthly loan admin fee. Instead of €5, we now charge €7, or a total of 3% of the credit amount, spread over the credit period. For example, if you borrow EUR 10 000 for 3 years, the monthly admin fee will is:

€10 000 x 3% = €300

€300/ 3 years = €8.33/month.

We decided this will be simply better for everyone: you get a credit with no upfront fees and we can offer you a convenient loan platform and an exceptional service.

 

So remember - no matter how the fees are structured, the APRC reflects the total amount of all charges paid in a year. It is the best and most accurate indicator of how much a loan will actually cost you. Therefore, APRC should be one of the most important indicators when choosing a lender.

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