Cost of Credit

Meaning and Definition

The cost of credit refers to the total amount a borrower pays for borrowing money, including interest charges, fees, and any other associated costs. It represents the overall cost of obtaining credit or financing.

Why it is important to know

Understanding the cost of credit is crucial for borrowers as it allows them to assess the affordability of the finance option and compare different loan offers. By considering the total cost, borrowers can make informed decisions and choose the financing option that best fits their financial situation.

Example in car finance

Suppose a borrower is considering two car finance options. Option A offers a lower interest rate but has higher fees, while Option B has a slightly higher interest rate but lower fees. To determine the most cost-effective option, the borrower needs to calculate and compare the total cost of credit for both options. This includes taking into account the interest charges, any upfront fees, monthly administration fees, and other applicable costs over the agreed-upon term. By comparing the total cost of credit, the borrower can choose the option that provides the most affordable financing solution.