Definition
The cost of credit refers to the expenses charged to the borrower in a credit agreement. This may include interest, commission, taxes, fees, and any other charges issued by the lender.
Calculating the cost of credit
Before you enter a car finance agreement (or any type of credit agreement), it’s important to understand how much the loan will cost. To work this out, you’ll need to consider the following factors.
Interest rate
Your interest rate is essentially how much a lender charges you to borrow money. It’s typically expressed as an annual percentage rate (APR), which refers to the yearly cost of interest on borrowed credit.
Generally speaking, the lower your APR, the smaller your cost of credit. For example, if you borrow £3,000 over a 12-month contract with a 10% APR, you would pay £300 in interest.
However, if you borrowed the same amount over the same period with a 15% APR, your cost of interest would be £450.
Your interest rate is calculated by the lender based on your individual circ*mstances, including your credit rating and affordability.
If you have an excellent credit rating, you will likely be offered a much lower APR compared to someone with a poor or bad credit rating. This is because a low credit score implies the individual is a greater risk to lend to.
Loan amount
When you take out a loan, the amount you borrow can have a significant impact on your cost of credit. In most cases, the more you borrow, the greater your cost of interest.
Let’s say you borrowed £10,000 over a 12-month contract with a 10% APR. Your total cost of interest would £1,000.
But if you were to borrow £5,000 over the same period with the same APR, you would only pay £500 in interest, reducing the cost of your loan by half.
Term length
Spreading your repayments over a longer period can be an effective way to reduce your monthly cost. However, borrowing money over an extended term is usually more expensive in the long run, as the cost of interest increases over time.
So, whilst a shorter term length may mean your monthly payments are a little higher, the overall cost of your loan could be considerably less.
Fees
Finally, fees. These vary from lender to lender and can include anything from late payment charges to settlement fees. They can also be expensive and often hard to spot, so always read your terms and conditions carefully to avoid any unexpected costs further down the line.
Get a free no-obligation quote
At Creditplus, we understand getting an accurate idea of how much a loan will cost can be tricky. But with our simple 2-minute application form, we’ll provide you with a free, no-obligation quote, without leaving any footprints on your credit profile.
You’ll also be able to discuss your finance options with a friendly car finance expert and ask us any questions. Apply now and a member of the team will be in touch soon.
