The Cost of Credit BBI2O Introduction To Business Unit 3: Finance 3.D Credit

The Cost of Credit Credit can be described as the privilege of buying something now and paying for it later When Credit is used*, consumers end up paying MORE for their goods The EXTRA amount of money paid is called the Cost of Credit * An exception would be if you used a Credit Card, and paid your balance in full by the due date

The Cost of Credit Forms of Credit –Credit Cards –Personal Loans –Car Loans –Mortgages –Store Credit Cards –Installment/Financing/Payment Plans –Loan Sharks/Mobsters

The Cost of Credit When we know the details of a financial transaction, we can determine the Cost of Credit This means we can determine the amount of extra money paid for the privilege of having it “now” and paying later Let’s see an example

The Cost of Credit - Example Mr. Borrower just bought a car for $16,450 –But he doesn’t have this much money in his account so he needs to finance

The Cost of Credit - Example He made a down payment of $2450 A down payment means he’s paid some of the amount, and financed the rest Therefore, he is financing $14,000 –($16,450 - $2,450 = $14,000) –(total cost – down pymt = principal)

So, the principal (borrowed amount) in this case is $14,000 The interest rate is 4%, paid monthly over 5 years Using a financial calculator, we can determine the monthly payment In this case the monthly pymt is $ The Cost of Credit - Example

So where are we now?? Our consumer pays $ each month for 5 years. 12*5 = 60 months! So how much money is that? $264.20*(12*5) = $15,852.00

The Cost of Credit - Example So we now know he’ll pay a total of $15, in car payments He’s also spent $2,450 for the down pymt Add these together: –$15, $2,450 = $18,302.00

The Cost of Credit - Example So our consumer has paid $18, for a car that was only priced at $16,450.00!! The difference between these two numbers is the Cost of Credit  $18, $16,450 = $1852

The Cost of Credit - Example So what does it all mean? –It means he paid a premium to have the car and use it while paying for it. The premium in this case was $

The Cost of Credit Discussion: –How can the cost of credit be avoided? –How can the cost of credit be reduced? –Why do people pay this extra amount? –Where does the extra money go?