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CHAPTER 6

THE COST OF CREDIT

6.2The Reasons for Indicating APR
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Giving a false or misleading indication, by any means whatsoever, of the price or charge for goods or services is illegal, under Statute, in both the U.K. and Ireland. (See Section 6.1.) The indication of the APR, when showing the cost of credit, is a means by which consumers are protected from such false or misleading representations. This will become clear from the following Illustrations.


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Illustration 1

Consider Case 1 as quoted by First National (see Appendix 1/2).

Amount Borrowed –––– £35,000 over 20 years

–––– quoted at a Mortgage Interest Rate of 11.85% p.a.


First National’s method of computing the Monthly Repayment Charge was as follows:

First National Repayments were computed by first compounding the interest charge annually, i.e. the End of Year Annual Repayment was computed using the Uniform Series Formula (F5).


R=P

P=£35,000

i= 11.85% p.a.

n=20 years

GivingR=£35,000

i.e.R=£4,641.77 / year


The End of Month Monthly Repayment charge to the Borrower was then computed by dividing this End of Year (Annuity) Payment by 12, the charge being £386.81 per month.


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Illustration 2

But, with some other Financial Institutions, that were competitors of the First National Building Society, Monthly Repayments were computed by compounding the interest charge monthly, i.e. the End of Month Monthly Repayment charge was computed by using the Uniform Series Formula (F5), with the Monthly Interest Rate being one twelfth () of the Mortgage % Interest Rate p.a. quoted.

So, for an Amount Borrowed of £35,000 over 20 Years at 12.06% p.a. (Illustration Example) the monthly Repayments would be computed as follows:

R=P

P=£35,000

i= 1.005% per month

n=240 months

GivingR=£35,000

i.e.R=£386.85 / month


So, while some competitor, who compounded interest on a monthly basis would be quoting a Mortgage Interest Rate of 12.06% p.a. to effect a Monthly Repayment Charge of £386.85 to the Borrower, First National were enabled, by their method of computing the Monthly Repayment Charge, to quote a lower Mortgage Interest Rate of 11.85% to effect a similar Repayment Charge, £386.81/month.


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Illustration 3

Alternatively, with some competitor Financial Institution that quoted a Mortgage Interest Rate of 11.85% p.a. (Illustration Example), where Monthly Repayments were computed by compounding the interest charge monthly (the monthly interest charge being one twelfth () of the Mortgage Interest Rate % p.a. quoted), the Borrower would only be charged Monthly Repayments of £381.73,

i.e.R=P

P=£35,000

i= 0.9875% per month

n=240 months

GivingR=£381.73 / month


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It is obvious from the above Illustrations that some standardised and TRUE INDICATOR of the actual interest rate being charged is necessary to make a fair and accurate comparison.

 

 

Copyright © 2013, 2014 John O'Meara. All Rights Reserved.