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Borrowing Basics

Truth in Lending Disclosure

The Federal Truth in Lending Act requires banks to state changes in a clear and uniform manner so you can easily compare the actual cost of borrowing. Just as you would do for any major purchase, shop around to find the best loan deal to meet your needs. This can save hundreds or thousands of dollars over several years.

For a closed-end loan (such as when you borrow a set sum of money to purchase a car), lenders are required by law to disclose terms such as the:

  • Annual Percentage Rate (APR)
  • Amount financed
  • Finance charge
  • Fees
  • Total of the payments

For credit cards, the lender must disclose key terms such as the:

  • Annual Percentage Rate (APR)
  • Fees
  • Grace Period
  • Balance Computation Method

Amount Financed

On an installment loan, this is the amount of credit the lender is letting you borrow. The amount financed will generally be the same as the amount of the loan, unless you have prepaid any loan fees or finance charges.

Annual Percentage Rate (APR)

The APR is the cost of borrowing money. It is the cost of credit stated as an annual percentage rate. It reflects both interest and other fees and costs defined as finance charges. It is the primary tool you should use to compare lending options.

Fees

Lenders must disclose the fees they charge for things like late payments. Make sure you check out what fees could be charged and how to avoid the fees.

Financial Tip

If you have a good credit history, you can probably find a credit card with no annual fee. If your current card has an annual fee, call your lender and ask them to waive it. They might do this rather than lose a good customer.

Grace Period

Grace period is the number of days you have to pay your credit card balance in full before the credit card company starts charging interest. Without a grace period, interest will be charged from the date you use your card or from the date each transaction is posted to your account.


Alternative Financial Services

Getting loans can be costly. However, getting a bank loan is usually less expensive than other alternatives. Potentially costly alternatives include:

  • Rent-to-own services
  • Payday loan services
  • Refund anticipation services

Rent-to-own

Rent-to-own services let you use an item for a period of time by making monthly or weekly payments. If you want to purchase the item, your rental payments will be partly credited toward the purchase price. The store will set up a plan for you to rent the item until you pay enough to own it. If you choose not to purchase, you would simply be renting the item to be returned at the end of the rental period.

The store is the legal owner of the item until you make the final payment. If you miss a payment, the store can take the item back. If this happens, you will not own the item, and you will not get your money back.

Rent-to-own agreements are technically not loans, so no interest is charged. However, the difference between the cash price (if you were to buy the item outright that day) and your total payment (the total of your rental payments over time) is like the interest you pay on a loan. Generally, using rent-to-own services is more expensive—sometimes much more expensive—than getting a consumer installment loan to buy the item.

Payday Loans

Payday loans (or cash advance loans) are short-term loans (usually up to two weeks).

  • You write a check payable to the lender dated two weeks from now and receive cash that day. The loan service cashes the check on your payday to pay the loan in full.
  • You can also go into the loan office and pay your loan with cash, at which point the lender returns your uncashed check to you.
  • You must be careful of payday loans. They are usually made to people who need money right away and plan to pay it back with their next paycheck.

Payday loans can be much more costly than they appear at first glance. If you do not have the money to pay the loan within the agreed-upon time period, the lender will renew the loan and charge you additional fees. This will increase the total amount you owe. Let’s look at an example of how payday loan services work. Assume you go to a payday lender and borrow $200:

Loan Term Fee You write a check for:
2 weeks $30 $230

The payday lender holds the check until your next payday. When the money is due, you can repay the loan by letting the lender cash the check, or you can give the lender the full amount due in cash, and get your uncashed check back.

The APR for this transaction is 391 percent! An APR for a typical payday loan may vary and may be even higher than this example. Most payday lenders:

  • Allow you to roll over, or renew your loan.
  • Charge an additional fee for renewal; in this case, you would write another postdated check.
  • Are usually not federally insured financial institutions or closely monitored by the Government as banks are.

Refund Anticipation Loans

Refund anticipation loans (RALs) are short-term loans secured by your income tax refund. Although the business preparing your income tax return will give you the money, you are actually receiving a loan from a bank or finance company. Because you do not have to pay any fees associated with obtaining a refund anticipation loan at the time you receive the money, you may not realize how much this loan is really costing you. For example:

  • Your refund is $1,500.
  • The fees associated with filing your income tax return with the tax preparation service and getting the refund anticipation loan equal $300.
  • You will receive a check for $1,200.
  • But you are actually paying $300 in fees to obtain your income tax refund.

It is important to remember that the paperwork you sign to receive a refund anticipation loan will legally obligate you to repay a $1,500 loan. The lender takes $300 of this up front and uses your actual $1,500 refund to pay for the $300 fee plus the $1,200 loan.

So, if your actual refund is only $800, you are responsible for repaying $700, plus interest to the lender that made the refund anticipation loan. And the higher the loan amount, the higher the refund anticipation loan fee will be.

Costs of a Refund Anticipation Loan

Here are some typical costs associated with getting a refund anticipation loan.

Total Cost   $300
Tax preparation fee   $152
Refund anticipation fee   $75
Electronic filing fee   $40
Document preparation fee   $33

When you electronically file (e-file) your tax return and request direct deposit, your refund is often deposited in your bank account within one or two weeks. Sometimes refund anticipation loans take just as long, yet cost you substantially more money. Ask yourself why you want to pay a sizable fee to get a loan against your tax refund rather than waiting a short amount of time for the refund to be issued by IRS.

Many organizations host Volunteer Income Tax Assistance (VITA) sites. VITA is an IRS-coordinated program that provides free income tax assistance and e-filing. Income eligibility restrictions may apply. Contact the IRS for a location near you.


When you Need Money Fast

It is two weeks until payday, your credit cards are maxed out, and your car breaks down. You only need a few hundred dollars for the repair but you need it now. Where can you get the money? Many people in these situations have turned to alternative financial service providers such as:

  • Pawn shops
  • Car title lenders (for a loan secured by the borrower’s car)
  • Payday lenders (for unsecured loans that borrowers promise to repay out of their next paycheck or regular income payment)

While these and other nonbank lenders advertise quick and easy cash, their services tend to come at a steep price.

Comparison Shopping

When comparison shopping for loans, look at both total dollar costs and the APR. For example, payday lenders typically charge about $15.00 for every $100.00 borrowed. So, on a $500.00 loan for two weeks, you’d pay $75.00 in interest. That might not sound like a lot of money to pay for a small loan, but it translates to a whopping 391% Annual Percentage Rate! And if you renew or roll over the $500.00 loan for another two weeks, you’d pay an additional $75.00 in fees. At that rate, in just 14 weeks, you will more in fees – $525.00 – than the original loan!

Instead, ask your bank about what options they may offer for you to borrow money on a short-term basis.