1. Why borrow money? Like Frank, sometimes we don’t have enough money in savings to pay for something that we need. For instance, we may be short of money to buy groceries or petrol while we are waiting for our wages to be paid to us. Alternatively, we may need to borrow a large sum to buy a car or a house. Before borrowing to pay for any good or service, ask yourself:
Borrowing Wisely LO 1.5
2. What is the cost of borrowing? Paying by cash is the cheapest way to buy goods. If we borrow money to buy goods we must pay interest on the borrowings. There are two main types of interest available, a flat rate of interest and an annual percentage rate of interest.
(a) A flat rate of interest A flat rate of interest means that the borrower is charged a fixed rate of interest each year on the original sum of money borrowed. It does not take account of the fact that the size of the loan is going down each year as it is being repaid. A flat rate of interest works out at a much higher overall interest charge than that calculated using an annual percentage rate of interest (APR).
(b) Annual percentage rate of interest (APR) The Annual Percentage Rate (APR) is the full rate of interest charged on a loan each year. The APR is calculated each year only on that part of the loan still to be paid back. It is also known as the true rate of interest. Lenders must include the APR in all their loan advertisements. When looking for a loan, consumers should always compare the APR rates of different lenders to identify the best value source of finance.
