Tuesday, July 3, 2018

0% Interest

Does a 0% interest loan sound too good to be true? You can get a 12-24 month installment loan from Brim Financial, and they claim to charge 0% interest. Not many borrowers will truly believe the cost is zero, but few will guess how expensive these loans really are.

Brim replaces “interest” with “fees”. There is a one-time installment fee of 7% of the loan amount that you have to pay in the first month. Then there is a 0.475% monthly processing fee. This fee is based on the original loan amount, not the declining balance owed.

Suppose you borrow $1200 for 12 months. The monthly payments before fees are $100. In the first moth, you pay the 7% installment fee ($84 in this example). You also pay a monthly processing fee of $5.70. In total, you pay $189.70 in the first month, and $105.70 for the remaining 11 months. The internal rate of return works out to 2.00% per month, and this compounds to $26.9% per year.

So, these carefully crafted loan terms combine 0% interest with a one-time 7% fee and an ongoing 0.475% fee to create a debt that costs 26.9% a year. That’s impressive ... and nauseating. Even those who read the fine print about fees are likely to think they’re paying a rate below 10%.

If you go for the two-year option, the cost compounds to 19.4% per year. That’s not much better, and you have to suffer through the payments for an extra year.

If this type of loan advertising is legal and remains legal, then it’s open season on borrowers.

3 comments:

  1. I am not good at financial math.. but
    total fee for 1 yr: $84+12*$5.7=$152.4

    Simple ratio: $152.4/$1200 = 12.6% ??

    How do you come up with 26.9%?

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    1. @Anonymous: Your calculation would apply if the entire $1200 + $152.40 were paid at the end of the year. But the payments are spread though the year with more than half of the "fees" paid almost immediately. This drives up the effective rate. From the lender's point of view, they get their money back sooner and can lend it out again. I got the monthly rate of 2.00% using the IRR() function in Excel, but it's easy enough to verify by hand. Just start with $1200, add 2%, and subtract the first payment. Then add 2% of what remains and subtract the next payment. By the last month you'll be close to zero.

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    2. Thanks for reply!

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