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CHAPTER 6

THE COST OF CREDIT

6.3The Potential to Mislead
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Let us now compare the APR in the three Mortgage Illustrations outlined above. For clarity of understanding refer back to each Illustration in turn. (See Section 6.2.)


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Illustration 1: APR Computation


First National Building Society (May 1991)

Amount Borrowed£35,000 over 20 Years.
Mortgage Interest Rate Quoted11.85% p.a.
Monthly Repayment Charge£386.81.

The Amount Borrowed is to be repaid by 240 End of Month Monthly Repayments of £386.81

Therefore:R=£386.81

P=£35,000

n=240 months

i=?



We want to compute the interest rate being charged over the time period increment, which in this case is one month.

Using Formula (F5)R=P

i.e.£386.81=£35,000



We want to compute the value of i that satisfies this expression.

By iteration, i computes at 1.005% per month.

The Monthly % Rate of charge is therefore 1.005%.



The Annual Percentage Rate (APR) of charge is computed by compounding the monthly % Rate of charge to 12 months.

i.e.APR=100


Note!
The expression gives the Annual Rate of Charge in terms of a decimal fraction; we then multiply this decimal fraction by 100 to convert to percentage.


i
=1.005% per month

n=12 months

Giving:APR=100

=12.749%


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Illustration 2: APR Computation


Some
Competitor Financial Institution. (Illustration Example)

Amount Borrowed£35,000 over 20 Years.
Mortgage Interest Rate Quoted12.06% p.a.
Monthly Repayment Charge£386.85.

Monthly Interest Rate Charged = 1.005%,i.e.

Giving:APR=12.749% (as already computed above)


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Illustration 3: APR Computation


Some
Competitor Financial Institution. (Illustration Example)

Amount Borrowed£35,000 over 20 Years.
Mortgage Interest Rate Quoted11.85% p.a.
Monthly Repayment Charge£381.73.

Monthly Interest Rate Charged = 0.9875%,i.e.

Giving:APR=100

=12.515%


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Comparing the above Illustrations:

Illustration

Quoted
Mortgage
Interest Rate

Computed APR

Indicated APR

1

11.85% p.a.

12.749%

12.7%

2

12.06% p.a.

12.749%

12.7%

3

11.85% p.a.

12.515%

12.5%


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From the above Illustrations it is clear that a statement of Annual Percentage Rate (APR) of charge provides the borrower with a statute defined yardstick that enables him to make a true comparison of the ‘cost of credit’ as charged by the various Lending Institutions.

It is also clear that the failure by First National / Irish Life to indicate the APR on their Mortgage Quotation would be likely to mislead a borrower; it would also be likely to afford First National / Irish Life an unfair advantage over a competitor Financial Institution.

 

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