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FINANCIALLY AESTHETIC · GUIDE 14/37
APR, INTEREST & THE REAL COST OF BORROWING
FA-3.1 · Debt & Borrowing
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THE COST QUESTION
The payment is not the price. APR, fees and time determine what borrowing really costs.
Understanding Personal Loans
Personal loans allow you to borrow a fixed amount of money and repay it over a certain period. Lenders may also refer to them as long term financing plans, installment loans, and consumer loans.
You must repay the entire amount, including interest and any applicable charges. You make regular payments, known as installment payments.
You can use personal loans for specific expenses such as home renovations, furniture, or a car. You can also use them for consolidation of other debts with higher interest rates. Most personal loans range from $100 to $50,000 and have terms of 6 to 60 months.
Principal, Nominal Rate, and Fees: The Components of Cost
The annual percentage rate (APR) of a loan - whether a consumer loan or a mortgage - tells you the total cost of credit for the borrower.
The APR allows you to calculate the total cost of your credit and compare offers as a whole, rather than just comparing interest rates.
Small differences in interest rates ultimately result in significant variations in the total cost of the loan.
The annual percentage rate (APR) takes into account all components of the cost of borrowing.
In addition to the loan’s interest rate, known as the nominal rate or debtor rate, the following must be included:
- handling charge,
- borrower’s insurance fees (when required),
- mandatory guarantee fees (mortgage, surety, etc.),
- fees for opening and account maintenance for a bank account opened to obtain the credit…
Even if these fixed costs are paid in a single lump sum at the beginning of the credit term, they are divided by the credit term to calculate them as a percentage.
Borrower Insurance Fees
In France, death, disability, and incapacity insurance - also known as “borrower’s insurance” - is required by financial institutions for all mortgage loans but not for consumer credit. The larger the loan amount and the longer the term, the more valuable this insurance becomes, as it relieves your heirs of any obligation to repay the loan.
Other types of insurance, such as job loss insurance, are optional.
As a reminder, the lender offering its own insurance contract for borrowers cannot require you to purchase it. You can choose individual insurance from the provider of your choice.
And for mortgages, all borrowers can switch their loan insurance at any time, once the loan agreement has been signed.
The new insurance contract offered as a replacement must provide a level of coverage equivalent to that of the group insurance contract.
Handling charges and other charges
Handling charges are charged by the lender when the loan is set up. They may also be charged if your application is rejected and your loan is denied. These fees cover the cost of reviewing the loan application. Depending on the type of loan and the bank, these fees may be fixed or proportional to the loan amount. They can amount to up to 1% of the financed amount.
Fees paid to intermediaries (such as a credit broker) who helped secure the loan must also be included in the calculation of the APR.
Incidental fees include costs the bank has incurred on your behalf, such as revenue stamps and registration fees (for example, for a lien on a vehicle). Generally, these do not exceed a few dozen euros.
Fees related to loan guarantees, which cover the risk of default not covered by borrower’s insurance. For a mortgage, these include mortgage fees or guarantees provided by a specialized company.
Fees associated with opening a bank account - opened with the lender to process repayment installments - must also be included in the APR calculation (account maintenance fee, direct debit fees, etc.).
The APR and the Usury Rate
The usury rate corresponds to the maximum rate at which a loan may be extended. The APR must not exceed the usury threshold applicable to the credit transaction in question. A loan is considered usurious when its annual percentage rate exceeds the usury rate set by the Banque de France for the current quarter.
Loan Term: What the Contract Must Specify
A federally regulated financial institution that extends a fixed-rate personal loan must provide you with certain information. This information includes:
- principal: the amount of the loan
- cash advances: the date the funds will be advanced and the date interest begins to accrue
- payments: the amount of your payments and their due dates, the frequency of payments, and a brief description of what each payment covers (e.g., principal, interest, and other charges)
- the loan term, which includes:
- the duration: the period during which your loan agreement will be in effect
- Loan type: whether your loan is open-end or closed-end
- a brief description of what an open or closed-end loan means, if applicable
- the amortization period: the time it will take to fully repay the loan, if different from the loan term
- the annual interest rate: the interest rate applied to your loan and, if applicable, how the rate is calculated
- the annual percentage rate (APR): the cost of borrowing, expressed as an annual rate on the principal, if different from the annual interest rate
- other charges: other types of applicable charges besides interest charges, such as non-sufficient funds fees
In addition to the information box, a federally regulated financial institution must provide details such as:
- the total amount you will have paid by the end of the loan term
- of that total, the total amount of fees you will have paid by the end of the term. For example, administrative fees, brokerage fees, or appraisal fees, if applicable
- the fact that your payments will first be applied to interest and other charges, and then to the principal that needs to be repaid
For a variable rate loan, the financial institution must also provide you with the annual interest rate applicable on the date of the initial disclosure, the method used to calculate that interest rate, and the date on which the calculation was made. It must also disclose the amount of each payment, calculated based on the rate of interest applicable on the date of signing, and their due dates, as well as the total amount representing the cost of borrowing that you will have paid by the end of the loan term: principal, interest, and other charges.
The Monthly Payment and the Total Cost: Two Figures Not to Be Confused
Borrowing money through a personal loan can be very expensive. Be sure to consider the interest rate, fees, and loan term.
When you take out a personal loan, your lender gives you an estimate of your regular amount of payment. To arrive at this amount, the lender calculates the total cost of the loan and divides that amount by the number of payments over the loan term.
The total cost of the loan includes:
- the loan amount
- interest on the loan
- all other applicable charges
To calculate the cost of your loan, you must factor in the interest rate, handling charges or other fixed charges, borrower’s insurance, as well as the loan term and repayment method. The longer the term and the higher the interest rate, the higher the total cost.
The total cost of your loan is equal to the difference between the total of the monthly payments (plus fixed fees such as handling charges) and the loan amount. Your banker must disclose this total cost to you.
This is the most common repayment method used for both consumer credit and mortgages. With an amortizing loan, each monthly payment is generally constant throughout the loan term. It includes a portion of principal and a portion of interest. The principal borrowed is “amortized” over the loan term.
Why a Lower Monthly Payment Can Cost More Overall
Make sure you understand the total cost of a loan before making a decision. Multiply the amount of payment by the number of payments in your term.
For example, suppose you want to take out a $2,000 personal loan. The interest rate is 19.99% on a monthly payment plan. The following example shows the total cost of a loan based on different terms.
| Option | Monthly Payment | Loan Term | Total Cost of the Loan |
| 1 | $185 | 12 | $2,220 |
| 2 | $75 | 36 | $2,700 |
| 3 | $53 | 60 | $3,180 |
Table 1: Example of the total cost of a personal loan based on different terms
This example shows that the longer it takes you to repay your loan, the more it will cost.
Even when mortgage rates are low - as was the case, for example, between 2019 and 2022 - extending the repayment term increases the overall cost. Also, a 20- or 25-year loan has a higher nominal rate than a credit with a shorter term. This becomes even more true as rates rise.
Example of the cost of credit for a €100,000 loan
| Term / Rate | 15 years / 2.7% | 20 years / 3% | 25 years / 3.4% |
| Monthly Payment | €676 | €555 | €495 |
| Cost of Credit | €21,723 | €33,104 | €48,584 |
Extending the term allows you to lower your monthly payments
Choosing a longer term for a mortgage (for example, 20 years instead of 15) usually means paying a higher interest rate for a longer period. The total cost of the loan is higher. However, the monthly payments are lower. If your primary goal is to stay within a certain monthly budget, this allows you to borrow more.
Suppose you can repay €1,000 per month. Given current interest rates, here’s what your borrowing capacity might look like:
| Term / Rate | 15 years / 2.7% | 20 years / 3% | 25 years / 3.4% |
| Principal Borrowed | €147,875 | €180,311 | €201,907 |
| Cost of the credit | €32,125 | €59,689 | €98,093 |
Extending the term allows you to borrow more!
Most loans are flexible: you can adjust your monthly payment to match your income. If your income has increased, this allows you to slightly raise your monthly payment. The goal: to shorten the loan term and thus reduce the total cost! Conversely, if you’re experiencing temporary financial difficulties, you can lower the amount of your monthly payment. Please note: This will result in surcharges.
The Impact of the Interest Rate on the Total Cost
The interest rate on a personal loan affects the total cost of the loan. By law, lenders cannot charge more than 35% interest annually. This includes all fees, costs, and interest you’ll pay to obtain the loan.
Suppose you want to take out a $2,000 personal loan over 36 months. The following example shows the total cost of the loan at different interest rates.
| Option | Interest Rate | Monthly Payment | Total Cost of the Loan |
| 1 | 8.99% | $64 | $2,304 |
| 2 | 19.99% | $75 | $2,700 |
| 3 | 34.99% | $92 | $3,312 |
Table 2: Interest on a Personal Loan
This example shows that a higher interest rate can significantly increase the total cost of your personal loan.
The interest rate a lender offers you may vary depending on:
- your credit history
- the type of lender
- the type of loan (guaranteed or unsecured)
A Special Case: the “balloon payment” loan
For mortgages, the loan is often an “amortizing” loan, but it is possible to opt for a “balloon payment” credit: in this case, the principal borrowed is repaid at the end of the credit term.
Each year, the borrower pays only the interest and the loan insurance.
The cost is obviously higher, since interest is calculated on the full principal amount throughout the entire loan term. Nevertheless, this option can be useful in two situations: when the borrower anticipates a cash inflow in the year the loan ends, or if the borrower can personally save the amounts they won’t have to pay each year and invest them at a sufficient rate of return (equal to or greater than the additional cost of the loan). This option is sometimes used for rental property investments to optimize the transaction’s tax implications, since the interest is deductible from property income.
A bridge loan functions like an interest-only loan, with a very short term, generally less than 24 months. As a general rule, the borrower repays only the interest and the insurance contributions during this period. The borrower repays the principal in a single lump sum upon the sale of the property.
Your Rights Regarding Cost Information
A federally regulated financial institution must provide you with information about your personal loan. It must do so in clear and simple language and in a way that does not mislead you. The nature of this information depends on the type of loan you have.
Before signing a personal loan agreement, take the time to read and understand its terms and conditions. Ask questions if you don’t understand something or if you’re unsure about what you’re signing.
Before executing a personal loan contract, make sure you fully understand the terms and conditions. Ask the lender questions if there is anything you do not understand.
Federally regulated lenders, such as banks, must provide you with the following information when you take out a personal loan:
- the loan amount
- the interest rate, and whether it is fixed or variable
- the loan term
- the amount of payments
- other charges and service charges
- any optional services you have agreed to
Other lenders, such as some credit unions, are regulated by provincial or territorial authorities. They may not be required to provide this information. Contact your provincial or territorial consumer information office to learn more about borrowing regulations.
BEFORE YOU SIGN
Compare total repayment and APR on the same amount and term before comparing monthly payments.
CURRENT-RULES CHECK
Legal protections, tax rates, reporting duties, deadlines and product rules change by country and over time. Use the jurisdiction labels in this guide and check the linked official source before acting.
- CFPB - Interest rate versus APR - United States - borrowing-cost terminology.
- CFPB - Compare auto-loan offers - United States - auto-loan comparison.
