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ou can make a purchase when you're lacking ready
cash.
But there are strings attached to credit too. It usually
costs something. And of course what is borrowed must be paid
back.
If you are thinking of borrowing or opening a credit
account, your first step should be to figure out how much it
will cost you and whether you can afford it. Then you should
shop around for the best terms.
What Laws Apply?
Two laws help you compare costs:
TRUTH IN LENDING requires creditors to give you certain
basic information about the cost of buying on credit or taking
out a loan. These "disclosures" can help you shop around for
the best deal.
CONSUMER LEASING disclosures can help you compare the cost
and terms of one lease with another and with the cost and terms
of buying for cash or on credit.
The Finance Charge and Annual Percentage Rate (APR)
Credit costs vary. By remembering two terms, you can
compare credit prices from different sources. Under Truth in
Lending, the creditor must tell you--in writing and before you
sign any agreement--the finance charge and the annual
percentage rate.
The finance charge is the total dollar amount you pay to
use credit. It includes interest costs, and other costs, such
as service charges and some credit--related insurance premiums.
For example, borrowing $100 for a year might cost you $10
in interest. If there were also a service charge of $1, the
finance charge would be $11.
The annual percentage rate (APR)is the percentage cost (or
relative cost) of credit on a yearly basis. This is your key to
comparing costs, regardless of the amount of credit or how long
you have to repay it:
Again, suppose you borrow $100 for one year and pay a
finance charge of $10. If you can keep the entire $100 for the
whole year and then pay back $110 at the end of the year, you
are paying an APR of 10 percent. But, if you repay the $100 and
finance charge (a total of $110) in twelve equal monthly
installments, you don't really get to use $100 for the whole
year. In fact, you get to use less and less of that $100 each
month. In this case, the $10 charge for credit amounts to an
APR of 18 percent.
All creditors--banks, stores, car dealers, credit card
companies, finance companies-must state the cost of their
credit in terms of the finance charge and the APR. Federal law
does not set interest rates or other credit charges. But it
does require their disclosure so that you can compare credit
costs. The law says these two pieces of information must be
shown to you before you sign a credit contract or before you
use a credit card.
A Comparison
Even when you understand the terms a creditor is offering,
it's easy to underestimate the difference in dollars that
different terms can make. Suppose you're buying a $7,500 car.
You put $1,500 down, and need to borrow $6,000. Compare the
three credit arrangements on the next page.
How do these choices stack up? The answer depends partly
on what you need.
The lowest cost loan is available from Creditor A.
If you were looking for lower monthly payments, you could
get then by paying the loan off over a longer period of time.
However, you would have to pay more in total costs. A loan from
Creditor B--also at a 14 percent APR, but for four years--will
add about $488 to your finance charge.
If that four-year loan were available only from Creditor
C, the APR of 15 percent would add another $145 or so to your
finance charges as compared with Creditor B.
Other terms--such as the size of the down payment--will
also make a difference. Be sure to look at all the terms before
you make your choice.
Cost of Open-end Credit
Open-end credit includes bank and department store credit
cards, gasoline company cards, home equity lines, and
checkoverdraft accounts that let you write checks for more
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