Chapter 18 Section 2 Cost of Credit

Finding Interest Borrowing money has a cost. Interest, I, is the cost of using someone else’s money. To determine the amount of interest on a loan, you need to know the following: Principal, P - Amount of the loan. Interest Rate, R – Percent of interest charged or earned. Remember that a percent can also be expressed as a decimal or fraction. The symbol for percent is %. Time, T – Length of time for which interest will be charged, usually expressed in years or parts of a year.

On single-payment loans, interest is usually simple interest. The equation for simple interest is: Interest = Principal x Rate x Time OR I = P x R x T The date on which a loan must be paid is the maturity date. Each payment made on a loan is an installment. With some loans, a promissory note is signed upon the release of the loan stating the agreement for the payments. The payment table and interest over time is called an amortization schedule. Before borrowing money or charging a purchase, you should know the exact cost of using credit. 3 things to consider when borrowing money are: Annual percentage rate, the total dollar charges, and the alternative sources of credit.

The annual percentage rate is a disclosure required by law. It states the percentage cost of credit on a yearly basis. The annual percentage rate includes other charges in addition to interest. Service fees involve the time and money it takes a creditor to investigate your credit history, process your loan or charge account application, and keep records of your payments and balances. Uncollectible accounts are frequently referred to as bad debts or doubtful accounts. To make you aware of the total cost of credit, federal law required that the lender must tell you the finance charge. The finance charge is the total dollar cost of credit, including interest and all other charges. Either your contract or your charge account statement must state this finance charge. If you have to borrow money or buy on credit, be sure to compare the total cost of credit among alternative sources.

Key Concepts Determine the best answer. 1.True or False. The principal of a loan is the total amount of interest that will be paid. 2.True or False. Interest rates are stated on the basis of one year even if a loan is for several years. 3.The most valuable number to consider when comparing credit among various borrowing sources is the a.Total finance charge b.Maturity date c.Annual percentage rate d.Principal