Often, when people borrow money, they do not know they are borrowing money: they are buying something on credit; they are delaying payment or staggering payment for something over a period. No matter how they view it they are, in effect, borrowing money to pay for the item now and repaying the loan over the agreed time. There will be a finance company involved and the customer will have to sign an agreement with them and will owe the money to the finance company and not to the shop.
Many shops want to sell items on credit because they have strong links to, if not ownership of, the finance company. They can sometimes afford to sell the items very cheaply and then make their money on the finance deal. With many stores still charging in excess of 25% APR this can mean a very healthy profit for them on items which they sell for barely more than cost price.
What is APR and What Does it Mean to You?
Annual Percentage Rate or APR is the standard measure for the cost of loans.
It is the gross amount of compound interest charged if no repayments are made. For example, imagine you borrow £100 from company A and do not pay anything back to them over the course of a year. At the end of the year you still owe them the original £100 plus another amount, let's say £10, in interest. That £10 indicates that there is an APR of 10% 1.
An APR can be seen as the price of a loan, so that you can compare one with another. At the time of writing this it is possible to obtain a loan from an Internet lender in UK at 5.9%. This means that if you were to borrow £100 you would owe them £105.90 at the end of the year if you didn't repay anything before then2.
If you are astute you will have noticed that the APR is equivalent to the pound3 price of borrowing £100. This makes comparison easier, which is what it was designed for.
So, when you see that the shop will charge you 29.5% on their 'easy credit' terms they want to charge you £29.50 for each £100 you borrow if you don't pay the instalments. If you borrowed at the bank at 5.9% you would be saving yourself about four-fifths of the credit charge.
And There's More
If you are sufficiently clever as to notice that you could save yourself some money by getting the credit elsewhere you may even be brazen enough to negotiate a discount for cash. This Researcher has negotiated such deals in several High Street outlets. A 5% discount covers the finance charges of the 5.9% loan, if repayments are made on time, over 12 months4.
Some lenders don't like to tell people what their rate of interest is. Be nervous if this is the case. Some bona fide companies regularly charge rates in excess of 150% APR and one major lending company was revealed on TV to charge in the region of 1000%. Rather than being some shady back-street loan shark, this was a fully registered and legal company operating in your neighbourhood5.
Avoiding High Interest Payments
Look around. Generally don't be tempted to take credit from the seller. This is often an expensive option. Ask to see the APR in writing before taking on the loan. Ask if there are any other charges (including expensive insurance) or penalties which you may incur.
Treat the loan or credit agreement as something you are buying. Would you want to pay £25 for something you could get for £5? Comparing APRs helps you to avoid that. Also look at the total repayment figure on any advertisements for items you are thinking of buying - especially cheap computers through the newspapers.
A computer with a cash price of £700 may seem cheap for a well-specified machine. If you aren't in fact paying cash for it the actual price you will pay is the credit price which is often given in the small print. This could be well over £1,000. Ask yourself if you would buy it for £1,000 in the first place or whether the deal seems less attractive now. It may be a better deal to buy a computer with a higher initial price tag but on interest-free credit or using a low interest loan. Or even better, get the cheaper machine but pay for it with a low-cost loan and avoid their own expensive credit.
Joe and Mary both want to get a new computer and they look through the newspaper. Mary looks for advertisements for cheap credit while Joe drools over the specifications of the computers. Mary finds she can get credit at 6% APR. Joe finds just the computer he wants and it's only £700 with easy credit terms and an interest-free period.
They show each other the advertisements they are interested in.
Joe: That's boring financial stuff! Why are you looking at that? Look at the memory on this - and it's got a DVD rewriter!
Mary: How are you going to pay for it?
Joe: I don't have to worry about that now. I can get six months' interest-free credit and then think about paying.
Mary: Well I like the look of the machine so I'll get one too - but I'll pay for it with this low-cost credit.
Joe and Mary get the same computer and they are very satisfied with them. Mary pays off her low-cost loan over one year on a monthly basis. The total cost of the computer (including credit) is under £740. When the six months is up Joe still hasn't sorted his finances out and takes the computer company's credit terms. By the time he has finished paying for it, it has cost him over £1,000.
Beware of the Penalties
When you make an agreement to repay a loan there is often small print about what the penalties will be if you miss a repayment. A credit card company, for instance, may say a late payment incurs a £15 charge - this is not included in the APR rate as the APR will not include penalties. If you continue to miss payments you will continue to incur penalties and begin to receive letters6. These are charged at another amount - all of these amounts7 are added to your outstanding balance. If you think that you cannot make a payment let the lender know - you may be able to negotiate with them. If you are finding debt unmanageable go to a free independent advice service, such as your local Citizen's Advice Bureau or a debt counselling service.
You will be surprised at the help you can receive and sometimes they may even speak to the lender on your behalf. All sorts of things can be negotiated including dropping the interest charges altogether in some circumstances.