A favorable interest rate quickly deceives that behind a loan may hide high overhead costs. Especially in the current low-interest-rate phase, the “almost free” loans thus lead to a possibly thoughtless borrowing.
Loans are a service…
… and benefits are usually not free. Even the seemingly free of charge provided zero-percent financing is usually associated with follow-up or additional costs. So many traders praise the credit costs directly in the selling price.
The crucial component for the cost of a loan is initially the loan amount. The loan amount decides how much the monthly repayment installment will be for a given term or how long the repayment period will be if the borrower can raise a certain monthly amount for the repayment.
The running time determines the costs
The total term of a loan is the period from the granting of the loan to the point where the debtor has repaid all costs, including interest, to the lender. It is contractually agreed between the parties.
The term has a significant share of the borrowing costs. The longer the term chosen, the more expensive the credit.
Although the monthly burden falls, but the interest costs increase each month and the risk of default is greater. Of course, lenders can pay for that, and it is not unusual for the interest rate to rise over the course of their term.
For installment, auto and residential loans, the normal period of validity is between 12 and 120 months, for a civil service loan up to 240 months. Construction loans have terms of up to 30 years due to the high sums.
The longer the term, the longer the capital of the bank is bound and can not be reinvested in other projects.
A calculation example:
|Duration of 5 years||Term of 10 years|
|loan amount||20,000 €||20,000 €|
|effective interest rate||2%||2%|
|Monthly Rate||350.40 €||183.86 €|
|Total interest and fees||1,023.81 €||2,063.78 €|
|Total expenses for the borrower||21,023.81 €||22,063.78 €|
The optimal runtime
A low monthly burden is initially tempting. Why not pay the loan in 48 installments of 100 euros instead of repaying 200 euros a month?
Quite simple: In a short term, the repayment is faster, the total credit costs are lower. However, not everyone can afford a monthly high rate.
When calculating the optimal repayment rate, you should consider how much money is available monthly. It is by no means a matter of saving the last penny from the mouth, but always also to consider a small buffer.
Because not every small unplanned event should lead directly to a financial distress, if the credit rates continue to be served.
To be considered are all monthly fixed costs such as
- Rental fee,
- Electricity and / or gas,
- Telephone, Mobile, Internet,
- Food and cosmetics,
- Fuel costs,
- Rates for existing loans,
- Club memberships.
Especially with longer-term loans, it makes sense to set the monthly costs slightly higher to allow for price increases. If children are planned in the coming years, the monthly fixed costs will increase as well and should be included in the calculation of the rate.
Calculation of the term
In addition to the online calculation by credit calculator, there is also a formula for calculating the repayment term:
Running time in years = – [(ln (1 – i * S 0 / R) / ln (q)]
Here i denotes the interest rate, S 0 the loan amount and R the annual interest and principal payment. q represents the annuity recovery factor and is calculated using the formula q = 1 + i.
Default risk – residual debt insurance
The longer the repayment term, the higher the risk that the borrower will become sick or unemployed, ie, unable to service his loan installments. To mitigate this risk, it is often necessary to take out a residual debt insurance policy, which at the same time represents a security for the heirs if the borrower dies.
If the insurance is optional, the costs add to the total cost of the loan. In the case of compulsory residual debt insurance, the lender must include the costs due for this purpose in the annual percentage rate of charge.
Effective interest rate and borrowing rate
The interest rate depends, among other things, on the term of a loan and the personal creditworthiness of the borrower.
Often confusing is the distinction between the APR and the borrowing rate. Only the effective interest rate allows a credit comparison. Especially with long maturities, the interest rate differentials are often large.
Here is worth a careful comparison of different providers. On the Internet, there are several comparison portals that provide a good overview within a short time.
The borrowing rate – also known as nominal interest rate – unlike the effective rate does not denote the total cost, but provides information about the pure interest rate that the lender demands for a loan. This is based on the current ECB interest rate.
For a monthly installment, as is customary for loans, the nominal interest divided by twelve months, with the remaining debt at the end of each month to interest this interest rate. Accordingly, the borrowing rate does not reflect the actual costs. But it is an integral part of the effective interest rate.
Effective interest rate
The annual percentage rate indicates the total annual cost of a loan in terms of the total and duration of the loan. The interest takes into account not only the actual debit interest but also the accrued compound interest as well as fees and other credit costs, whereby the classical processing fees are no longer correct.
Since 2010, the indication of the effective interest rate is mandatory throughout Europe for installment loans. Components of the APR are in accordance with the Price Indication Ordinance:
- any interest prepayments (so-called discount),
- the nominal interest rate,
- the calculated repayment installment,
- Brokerage fees,
- Closing costs.
By specifying this effective interest rate, a credit comparison is possible. However, there are fees for examiners and appraisers, account maintenance fees, partial payment surcharges and provisioning fees.
The calculation of the annual percentage rate
Effective annual interest rate in percent
[Credit Cost x 24 x 100%] / [Net Loan Amount * (Term in Months + 1)]
- Net loan amount = loan amount – borrowing costs,
- the costs are composed of interest on a loan + processing fees + insurance contributions for any required residual debt insurance,
- the processing fee is processing fee in percent * loan amount: 100,
- the interest is calculated by interest rate in percent x loan amount x term: 100.
Some lenders do not grant free special redemption rights on the loan. This means that a borrower, in the event of early repayment of his loan (eg in the case of an inheritance) pays the bank a sum X which offsets income through interest losses.
Due to this so-called prepayment penalty, it is worthwhile to calculate whether a premature repayment is actually more favorable than the planned repayment of the loan within the regular term.
For some loans, the actual loan amount differs from the amount paid out. This difference – a discount or an interest prepayment on the loan amount – is called a discount. In return, the bank calculates a lower nominal interest rate on the loan.
The discount is less common in traditional consumer credit, but often plays a role in real estate loans. If the foreign use of this property, the discount may offer tax benefits.
There should not be any hidden costs. Processing and loan fees must be mapped as well as a mandatory residual debt insurance in the APR. Only a residual liability insurance, which is optional, represents an item that does not appear in the total cost of a loan.
However, the issue of hidden costs is more complex in a construction loan. Here it is important to pay attention to other factors in addition to the construction costs.
Total cost of mortgage lending
In the case of mortgage lending, either costs for the land and the purchase price (for new buildings) or for the purchase price as well as any renovation and conversion costs (for existing real estate) are incurred. In addition there are notary fees, brokers and land register entry, land transfer tax, costs for the architect and insurance, if necessary for an appraiser and the move. All these factors must be taken into account when calculating the loan amount.
If the bank has approved the loan, the so-called construction lending interest accrues until the completion of new construction or reconstruction. These are financing costs that the bank incurs if a loan is not paid in a sum but according to the construction progress. They are composed of:
- Commitment rate for unpaid loans,
- Contract interest on loans already paid out.
Order a mortgage
To secure a loan, the bank often demands a mortgage. On this basis, a quick foreclosure sale is possible in the event of insolvency. The costs for this amount to about 0.5% of the loan amount.
For construction loans, the parties set a fixed interest rate for a period of about ten years. Within this period, the Bank has no option to adjust the interest rate to market developments.
After expiry of the deadline, a new interest rate is set, whereby the borrower can consider whether to continue the loan with the previous bank or to repay it by taking out a new loan. This is common practice when other banks promise more favorable terms for the remaining amount.
A loan hides several cost factors that borrowers should consider. In addition to the loan amount, especially the duration is crucial for the total amount of the loan.
Here, it is worthwhile to carefully examine your own financial situation over the entire term and to calculate the monthly repayment installments that are possible without a loss of liquidity. The optimal compromise between monthly installment and runtime is the lowest cost.
The annual percentage rate gives an important clue in a credit comparison. But even here should be paid to the decision on additional costs, which may increase the cost of a loan under certain circumstances.