## 7 Feb 2012

### Credit cost calculation and Simulation tips

It is often said that you should never take a loan, because it’s expensive. It is always better to pay cash, it's cheaper. This is very true, to some extent, because it's not that simple. The true price of credit is not necessarily who you think, and it may be advantageous to make a loan! A credit can save you money, or, failing that, in quality of life.

To understand the price of a credit, you must always take into account the inflation explanations.

Summary

*Credit cost calculation
*The APR
*Cost of mortgage
*Calculation of the credit period
*Calculating the cost of credit

We must understand one thing, the concept of inflation. Everyone knows that the prices of things increase over time. The price increase is called inflation. Let's see how inflation is related to the price of credit.

Let's say I buy a sofa on credit which costs 1000 Bucks. I am willing to save the cash purchase, but I'm not going to sit on the floor for a year while waiting for the money, though? And that tells me it will cost more than 1000 Bucks a year? With inflation, it may cost more!

There is another factor to consider: if you save to buy your sofa, it means that maybe you will put this money into a savings account, waiting to have the sum, is not it? And of course, it generates savings account also of interest in your favor this time. We can say that your 1000 Bucks obtained after one year you would still have to generate 10 Bucks interest. By buying right away, you will not receive the interest, so it's less money for you.

Conclusion: by buying in a year, you pay no credit, and you earn interest on the amount saved: that will cost 1050 Bucks to the sofa in a year, so add 10 Bucks in lost revenue, not the sofa you would then have a final cost that from 1050 to 1010 Bucks 1040 Bucks.

But if I had taken a loan with interest at 6% Finally, I would have paid 1,060 Bucks after a year. The credit cost me 60 Bucks. But if you look at its current price of 1050 Bucks, the true price of credit is 60 - 50 Bucks 10 Bucks, which are added the 10 Bucks that would have been through savings, 20 Bucks in total.

And yes, the sofa will have cost me no more than 20 Bucks, but that I can use it for a year! The failure to use the couch for a year also has a cost: the quality of life, comfort, things untold. All for 20 bucks, so of course we must do a bit of futurology: what is the price that you want to buy today in the future?

What is the APR rate?

The APR is the real cost of credit. This is the value you need to look to compare different credit offers that come your way. Method of calculation, so it's a safe bet for the consumer credit applicant. It is calculated by including all expenses related to credit: the interests of course, but also the application fee or any insurance required by the type of credit. The lender is obligated by law to state the APR, it is often written in small print in the disclaimer at the bottom of ads for the credit. This is the main protection of the credit applicant, which allows a simple and reliable figure. Previously, banks and other lending companies could mask the true cost by increasing the cost of insurance or fees, which gave the impression of getting a good rate. Difficult then to know how much is really the credit, if one is not very good at math!

Calculating the cost of mortgage

Before buying an apartment or a house, one asks, of course, always the question of financing and mortgages. We need to think not at the price of what one wants to buy, but rather how can we repay the bank each month. The rule is simple: one third of our revenues may be spent on all outstanding loans, the debt ratio. It is this value that everything else follows. If you want to buy bigger, we will repay over time, but always the same amount of money each month.

The cost of credit is of course the total interest paid to the lender, the bank. Over the repayment period is longer, the mortgage will cost much. But again, we must take into account other costs, such as not to live in an apartment big enough. This is not a monetary cost, but it is a psychological and social cost, it must of course be overlooked.

Cost of bridge loan

In these calculations the cost of a mortgage, plus interest, must also think about the potential cost of a bridge loan. This loan is that the bank gives you for buying your apartment, pending the sale of your property today. It only applies to people who already own, and who must sell to move.

Calculation of the credit period

The credit period is calculated from what we can repay each month. If you want to pay a minimum of interest, it is better to pay as much as possible and as quickly as possible. If you want to pay as little as possible each month, its best stretch as much as possible the duration of the price, but the cumulative interest paid will be quite high. Just do a simulation on any site which allows it: the longer term, the more it pays interest. Personally, I prefer to take just one credit short! The mortgage answers to these rules of course, better to ensure that credit is as short as possible, even to move again if necessary.

The golden rule is to never take a credit that may be a risk to the person. It should be safe as long as possible; you can pay it back, whatever happens. A very long to pay off credit risk increases, we do not know what could happen to us during our lives. A credit is shorter and less risky, even if the monthly payment per month is more expensive: we can extend the repayment period, which is not the case of a credit for which it had already spread to maximum repayment period...

Or does it not get credit?

So there are things: that are best buy on credit if they are needed, and others not. Anything that depreciates rapidly due to technological change and who can wait, it is better to pay cash, with hard cash. For example: a computer, a mobile or even a car. Will you buy in a year will probably be better and cheaper, so why buy the latest fashionable mobile on credit? If you already have a car, same old, or a mobile phone, wait until you have the money to pay cash or you may go for used ones to buy much affordable option.

By cons, things you buy and that does not depreciate much over time, such as furniture or real estate, there is not really hesitate, credit is a good option. You will not necessarily be a better couch in one year, or a better house, for against it may very likely increase in price by then ... This broadly course. We know that right now the housing prices are in turmoil. If anything, the apartments will be cheaper in a year, which is very likely! But if they increase by 10% and that your interests are at 6%, you earn money, because your home will be worth more than the interest you pay.

To find out if it is worthwhile for you to take a loan or not on property that is not strictly necessary, remind you of the following:

Always compare with the inflation forecast, and the evolution of prices on what you want to buy more precisely.
Look at the APR of the credit for that property, the total cost of credit.
Calculate the money you would have earned in interest if you had saved to buy this property
With these tips, I hope you see more clearly into the true cost of credit, and you can make the right choices.