Sunday, April 19, 2015

How much does it cost to borrow money?

So many banks, so many choices ...

How to get most loan mileage?

In Sweden, the lowest interest on an unsecured loan to day is 3.50%. Unsecured loans are offered by many banks which specialize in this type of loan. Examples of such banks are Nordax, Marginalen Bank, Bank Norwegian, Santander, Collector, Spring Finance amd Sevenday Finance. These banks differ in how they calculate individual interest rates on a loan, based on your financial situation payment ability. To find the lowest interest rate you therefore have to apply for a loan with many banks, which can require a lot of effort.

A loan broker removes hassle and lowers cost

The easiest way forward is therefore to apply through a loan broker. The loan broker mediates your application to a number of banks  (googling  the term "loan broker" will supply numerous suggestions). This will increase your chances of being offered the best loan the market can offer, whether you are on the lookout for certain loan amount, interest or lowest monthly cost. This approach will quickly give you an overview of your possibilities and make it easier to make an informed choice. One example of such a service in Sweden is Låna Penger.

Factor in the fees

So what does the loan cost? When you know the interest rate it is a simple matter to calculate the monthly cost and overall outlay for the loan. You do need to keep in mind that a loan in most cases has a cost associated with establishing the loan (start-up fee) and a monthly invoice fee. The effective interest takes these costs into account, giving you a more objective measure when you compare different offers. (You can use the LoanWise calculator!).

Think of it as a long term credit

For many the monthly outlay including the fees is the determining factor when choosing a loan offer. This is after all the direct impact on our private economy. To achieve the lowest monthly cost, all other factors being equal, choose the loan with the longest tenure (payback time). There is little risk involved. Remember that a loan can be paid back in larger installments any time you choose, and even be consolidated in its entirety. In this way of thinking the loan is a long term credit with a fixed cost, which you can pay back at any time.

Monthly cost of loan: 1%!

Given all of the above, let's do the maths on a loan with a tenure of 12 years (many banks in Sweden offer up to 15 years!):

A loan of 100 000 SEK with a 5% interest will cost you 925 SEK per month. Assuming a typical start-up fee of 500 SEK and an invoice fee of 30 SEK, the effective interest is 5.84%. Paying back the loan in accordance with the standard installment plan (annuity) will cost you 138 005 over the course of 12 years. A rule of thumb is that the monthly cost for a loan in many cases is approximately 1% of the loan amount.Thus a loan of 150 000 SEK will cost about 1 500 SEK/month, whereas a loan of 200 000 SEK will set you back 2 000 SEK/month. Use the LoanWise calculator to get more exact values!

This post is a translation of an article in swedish, published in Ekonomian 

Thursday, February 27, 2014

What is a credit score?

A credit score is a measure of how risky you are perceived by the lender

Credit ratings come in to variants: off-the shelf credit scoring and internal credit scoring.
Off-the-shelf credit ratings are offered by companies that have specialized in scoring people's credit worthiness. Two well-known companies are Experian  and  Dun&Bradstreet. Both companies offer personal online credit scoring in many countries. Their main business however is to supply credit scores to other businesses such as banks, telecom and utility companies. Whenever you enter into a new customer relationship with a company, chances are you will be scored.

Credit score determines loan amount and interest

Most lenders also have their own internal credit scoring, often used in combination with an off-the-shelf score. This is known as a score card. The score card is a well-guarded secret which has been developed through experience over many years. The score card will take into account all the information you supply in connection with applying for a loan, combine this with information that is available through public registers (for example tax registers, debt databases), and reduce this to a single digit, say between 0 and 100.

Your credit score determines how much you can borrow. Many lenders (banks) often use risk-based pricing which also determines what the interest rate should be. Practices vary, so fixed pricing (a flat interest rate) is also common.

Use loan brokers

The bottom line is that your credit score is all-important in determining the conditions for your loan, and will vary from one bank to another. Therefore, to get the best conditions you should always apply for a loan from different banks if possible. Loan brokers, such as Axo Finans AS (Norway) and Axo Finans AB (Sweden) can help with this process. You need only fill in one loan application, and they will apply in a number of different banks to get the best offer. To find loan brokers near you, just google the term "loan broker".

Monday, February 24, 2014

Introducing the loan calculator

The loan calculator can be used on any type of installment loan, e.g. a mortgage or personal loan (unsecured loan). Note that even though I have used $ as the denomination, the loan calculator can be used for any currency, be it euros, kroner or whatever. The loan calculator is a useful tool to determine:
  1. Lifetime cost of the loan: The total layout you have in borrowing the loan amount over the lifetime of the loan
  2. The monthly cost of the loan: Your monthly installment (down payment)
  3. The effective interest rate: A measure of the actual interest you pay when all costs are taken into account
You can use the calculator when you want to:
  • Compare different loan offers
  • Calculate the costs of taking up a loan
  • Explore the effects of changing loan conditions, for example the tenure (loan duration)
When considering a loan you should note the following (explore it in the loan calculator!):

A longer tenure (loan duration) gives a lower monthly cost. If you are concerned about your monthly cash flow, consider increasing the tenure. Remember you can always choose to amortize (pay down) the loan earlier, in part or whole.

The smaller the loan, the higher the effective interest.The costs of establishing and running a loan (e.g. monthly fees) tend to be similar regardless of the loan amount. This means that the effective interest rate will tend to be much higher for smaller amounts, particularly in combination with shorter tenures. This is why lenders are interested in selling small loans with a small duration!

A practical note: remember to click the calculate button to reflect any changes you make. Let me know if you see any improvements!

Saturday, February 15, 2014

Interest rates should interest you

Interest rate is the price we pay for money. Money is a commodity like most things we consume in our daily lives such as groceries, gasoline or movies. Most of us pay for money through an exchange of money for work. More often than not, the money we get from working is not sufficient for our needs, be it due to a housing project or unforeseen medical bills. We could work more, but we also want a life! Thankfully it is possible to "buy" money to cover these surplus needs.

The way we buy money is through an exchange of money on hand for future payments. If we pay the money vendor (or lender - often a bank) more than we have received, the vendor will make a profit. How much profit the lender will wish to make from you is dependent on two main factors:

  • The amount of competition between lenders
  • The risk of you not being able to make the future payments

This is how the market works. If there is a lot of surplus money combined with competition among lenders, the general price for money will decline. More importantly however, the lender will set an individual price based on how risky your future payments are perceived. The result is that there will be a range of interest rates within most categories of loan, often substantially higher than the general interest rate.

As a consumer you cannot influence the general interest rate. However, you can influence how risky you are perceived. There are a number of practical measures you can take to reduce the risk associated with you! Read more about this in the post "How can I influence my credit rating?"