If we decide to run a simulation on any credit, it is mainly to measure what will be the rate of effort we will have to make to repay it. Because it is well on monthly payments that our eyes arise. And this monthly payment is a function of several parameters; the credit rate, its repayment term, and, of course, the amount borrowed. The same is true for a revolving credit as for any other credit. Even though here we have the option to choose the amount of our monthly payment.
Knowing this, let’s take a closer look at revolving credits. Because these are very particular. To start with their rates. For the same amount borrowed, a revolving credit can be both much cheaper and much more expensive than a depreciable loan. Simply because of the repayment term. There is no prepayment penalty on a cash reserve. It is even one of the basic principles of this type of product; to be able to repay the entirety whenever we want.
So, for an equivalent amount, if we choose a very long term, the repayment will be fast, and will not cost much in interest. But if we opt for a low monthly payment, in order to preserve our monthly budget, then the cost will skyrocket. The staggering of repayments will be all the longer as the monthly payment is low.
Because a small calculation will always be clearer than a long speech, let’s take a concrete example. Let’s request an envelope of 6,000 $ on a revolving credit. And immediately spend $ 1,250. Let’s see what the simulation gives.
Before going any further, note that the new provisions in force since the implementation of the Lagarde laws consider that a revolving credit must be repaid within a maximum period of three years if the amount borrowed is less than $ 3,000. This is the case in our example.
If we choose for the lowest possible monthly payment, that is, the one that gives us 36 months to repay, we get this:
A monthly payment of nearly $ 52, for a total cost of credit of nearly $ 600. In terms of capital / interest, this gives us a fractional monthly payment as follows: $ 34 of capital repaid, for $ 18 spent on interest and loan insurance. But the most important figure is the total cost of credit. As you can see, taking our time, so as not to burden our monthly budget, we reach a total cost of almost 50% of the value borrowed!
For comparison, double our monthly deadline:
For 104 $ monthly, we refund in 15 months. But the most important thing to note is here: Out of these 104th monthly payments, only 20 $ are devoted to interest and insurance. This is due to the calculation of repayments of revolving credits. The sum of the interest is almost fixed, regardless of the amount of the monthly payment. So a low monthly payment increases the cost drastically. In fact, the more tight our budget, the lower the deadline, and the more we pay … In this second example, the total cost of interest and insurance amounts to less than 20% of the amount borrowed.
In fact, it does not matter what the rates are. It is the repayment term that will make the cost of your loan. And that’s why revolving credits can turn out to be pitfalls. That is why, moreover, the package Lagarde laws provides that for any amount over $ 1 000, an adviser must be able to offer a depreciable loan, in order to establish a comparison in repayments.