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|Interest Rates 2 (The Amstrad User)||Applications Bureautique|
Petr Lukes is back with another interest listing for those who like to ponder their future loan repayments.
The size of consumer debt and Its cost brings frequent calls for the reform of credit legislation. One of the suggested reforms Is the requirement for better reporting of effective Interest rate charged for the loan.
Most consumer loans are short-term and the Interest quoted Is the flat rate for the term of the loan. An oversimplified example may illustrate the terms:
Supposing we borrow $100 at 10% for two years, the loan to be repaid by two equal Installments at the end of each of the two years.
Under the flat rate interest terms, the Interest for the life of the loan is added to the principal and the total divided by the number of repayments: in our example the total will be ($100x10%) x 2yrs-$120. and will be repaid by two Installments of $60 each. Simple and seemingly reasonable, but a breakdown of the two repayments shows an anomaly. At the end of the first year we owe $100 plus Interest. i..e. $110. The first Instalment of $60 pays the Interest and reduces our debt to $50. At the end of the second year we repay the $50 principal and the remainder of the Instalment, $10 Is the interest component. Since we owed only $50 at the beginning of the year, the effective interest rate for the second year Is 20%. twice the quoted rate.
If we paid interest only on the sum owing, the two equal repayments would amount to $57.62. The first repayment pays the $10 interest and reduces the debt to S100.00-$47.62=$52.38. The second repays the outstanding principal and its associated 10% Interest: $52.38*$5.24-$57.62. The difference in total Interest paid does not appear to be great ($15.24 as against $20). but loans are usually paid by monthly Installments and the difference becomes more significant.
The relationship between the flat and the equivalent reducible Interest rate Is quite complex and has no exact solution. The programme asks for the term of the loan in years and the quoted flat Interest rate and works out the equivalent reducible rate by successive interpolation between guesses at the solution. The differences for short-term loans are quite marked: for a one-year loan, repayable by monthly Installments, a flat rate of 10% actually represents an 18% reducible rate.
Lenders usually impose some establishment charges which may be added to the loan or have to be paid before the loan is granted. Either way. the cost of the loan Is higher than It would appear from the quoted rate. As well, for some short term risky loans, the repayments must be made in advance, the first one at the time of granting the loan. In case of. say a $100 loan with repayments of $10. the actual amount lent is $90 while interest Is charged on the nominal $100. There Is virtually no limit to the possible variations, and arriving at the true cost of the loan can be a complex exercise.