The Real Cost of Credit
October 21st, 2010 | 
Author: The main criteria taken into account when evaluating the various banks or financial institutions that can give a company a loan is the interest rate they charge.
However, the interest rate that banks charge promise and financial institutions is not representative, because there are other additional costs that are included in the loan, such as costs of issuance or maintenance, which are not shown clearly and that raise the cost of credit.
So when evaluating and comparing different financial offers that exist in the market, rather than taking into account interest rates, which in reality we must take into account is the total cost of financing (known as cost effective or total financial cost), which includes the interest rate plus other costs.
Here’s an example, suppose we want to acquire a loan of 1000 for a period of 5 months. Suppose Bank A offers charge a monthly rate of 4%, while bank B offers charge a monthly rate of 5%. At first glance it appears that Bank A is the most convenient option because we charge the lower rate, however, if we take into account the additional costs included in the loan:
To see that the bank offers the lowest interest rate, but, taking into account the additional cost (execution, delivery fees and maintenance) charges, the total cost of funding it provides is greater than that offered by bank B, so the latter would actually be the most convenient option.
Therefore, the recommendation is that when evaluating a financial credit, before taking into account interest rates, which in reality we must take into account is the total cost of financing (which the bank or financial institution is in obligation to provide it), which is actually the true rate of interest payable.
