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 Consumer Handbook
to Credit Protection Laws Part 2
A Comparison
Even when you understand the terms a creditor is offering, it's easy to underestimate the difference in dollars that different terms can make. Suppose you're buying a $7,500 car. You put $1,500 down and need to borrow $6,000. Compare the three credit arrangements in the chart on the next page. How do these choices compare? The answer depends partly on what you need. The lowest cost loan, in terms of total finance charges and total of payments, is available from Creditor A.
|
APR
|
Length
of Loan
|
Monthly
Payment
|
Total Finance
Charge
|
Total of
Payments
|
| Creditor A |
14% |
3 years |
$205.07 |
$1,382.52 |
$7,382,52 |
| Creditor B |
14% |
4 years |
$163.96 |
$1,870.08 |
$7,870.08 |
| Creditor C |
15% |
4 years |
$166.98 |
$2,015.04 |
$8,015.04 |
If you were looking for lower monthly payments, you could get them by repaying the loan over a longer period. However, you would have to pay more in total costs. A loan from Creditor B, also at a 14 percent APR, but for four years, will add about $488 to your finance charge.
If that four-year loan were available only from Creditor C, the APR of 15 percent would add another $145 or so to your finance charges, compared with Creditor B.
Other factors, such as the size of the down payment, will also make a difference. Be sure to look at all the loan terms before you choose.
Cost of Open-end Credit
Open-end credit includes bank and department store credit cards, gasoline company cards, home equity lines of credit, and check-overdraft accounts that let you write checks for more than your actual balance with the bank. Open-end credit can be used again and again, generally until you reach a certain prearranged borrowing limit. Truth in Lending requires that open-end creditors tell you the terms of the credit plan so that you can shop and compare costs.
When you're shopping for an open-end plan, the APR is only the periodic rate that you will be charged, figured on a yearly basis. (For instance, a creditor that charges 12 percent interest each month would quote you an APR of 18 percent.) Annual membership fees, transaction charges, and points, for example, are listed separately; they are not included in the APR. Keep these fees in mind and compare all the costs involved in the plans, not just the APR.
Creditors must tell you when finance charges begin on your account, so you know how much time you have to pay your bill before a finance charge is added. Creditors may give you a 25-day grace period, for example, to pay your purchase balance in full before you must pay a finance charge.
Creditors also must tell you the method they use to figure the balance on which you pay a finance charge; the interest rate they charge is applied to this balance to compute the finance charge. Creditors use a number of different methods to arrive at the balance. Study them carefully; they can significantly affect your finance charge.
Some creditors, for instance, take the amount you owed at the start of the billing cycle and subtract any payments made during that cycle. New purchases are not counted. This is called the adjusted balance method.
With the previous balance method, creditors simply use the amount owed at the start of the billing cycle to compute the finance charge.
Under one of the most common methods, the average daily balance method, creditors add your balances for each day in the billing cycle and then divide that total by the number of days in the cycle. Payments made during the cycle are subtracted to get the daily amounts, and depending on the plan, new purchases may or may not be included. Under another method, the two-cycle average daily balance method, creditors use the average daily balances for two billing cycles to compute your finance charge. Again, payments will be subtracted to get the balances, but new purchases may or may not be included.
Be aware that the amount of the finance charge will vary considerably depending on the method used, even for the same pattern of purchases and payments.
If you receive a credit card offer or an application, the creditor must give you information about the APR and other important terms of the plan (for example, annual fees and late payment fees) at that time. Likewise, with a home equity line of credit, this information must be given to you with an application.
Truth in Lending does not set the rates or tell the creditor how to calculate finance charges, it requires only that the creditor tell you the method that it uses. You should ask for an explanation of any terms you don't understand.
Credit Protection Laws
Part 1 - Part 2 - Part 3
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