FLM Step 27: Counting the cost of credit
In honor of Financial Literacy Month, we created a microsite that offers 30 simple steps to financial wellness–one for each day of the month. To enrich the experience, we asked some amazing people to guest post during the month on a topic that is related to the day’s step. Their dedication to financial literacy is truly inspiring! Today, Wise Bread blogger Julie Rains talks about the cost of credit.
When I consider the cost of credit, two categories come to mind: financial and psychological. Financial Costs Most borrowers will consider these elements in making a borrowing decision:
• Monthly payment - can I make the monthly payment?
• Interest rate - does the interest rate seem reasonable?
• Total interest paid over the life of the loan (for example, a $200,000, 30-year, 5% fixed-rate loan will cost more than $186,500 in interest; credit card interest rates may run from 7.9% to 29.9% or more, dramatically increasing the cost of a purchase);
• Fees associated with obtaining credit such as mortgage loan closing costs (which may run 2.5% of the total loan value) and convenience check charges (often 3% of the check amount, which added to even a low teaser rate of 2.99% can make a substantial difference in the cost of credit);
• Unexpected fees such as late-payment fees;
• Even moderate amounts of debt can prevent borrowers from saving and investing, foregoing interest earnings on savings account or potential investment growth.
• Too much debt can cause stress, especially if income covers monthly payments only and not eventual payoff of a mortgage loan or credit card charges.
• Outstanding loans can be a burden for some borrowers, keeping them tied down to the past (making payments on items purchased, used, and discarded long ago) rather than moving forward with the future (such as saving for a new home or major home improvements, college for their children, or retirement).
There can be benefits to credit as well, such as being able to lock in a price for a new home at a good price with affordable payments, purchasing a car to provide transportation to work, or obtaining a student loan to attend college. It is helpful, though, to consider the entire cost of credit, and not just monthly payments, in making an informed decision to buy now, pay later.
Julie Rains is a Senior Writer for Wise Bread and a freelance writer specializing in career services. She holds a BSBA-Finance, Kenan-Flagler Business School, UNC-Chapel Hill.