What Is a True Interest Cost?

Esther Ejim

A true interest cost is the actual cost that is attached to obtaining some form of loan facility, some of which may not be immediately apparent until a careful scrutiny of the terms for the loan is undertaken by an interested party, such as the person seeking to obtain the loan. Most times, the real conditions for obtaining a loan or credit may be hidden in such fine print that the person seeking to obtain the loan might not be aware of all the consequences for obtaining the particular loan. Some of these factors are finance charges, including the real annual percentage yield on credit cards. Since some unscrupulous lenders had persistently hidden the true interest cost for loans or the extension of credit facilities, some countries have enacted laws meant to specifically address such unethical business practices.

Man climbing a rope
Man climbing a rope

In the United States, the law that addresses the propensity for lenders to hide the true interest cost in their lending practices is the Truth in Lending Act (TILA). This is a federal law that directly prohibits such practices and lists the types of information lenders must disclose to potential borrowers before they are locked into any credit agreement or any other type of financing agreement. As a result, when someone applies for credit and is approved, disclosures regarding the true interest cost will be written in a conspicuous manner on the various correspondences between the lender and the borrower with the aim of avoiding any misunderstanding or ignorance of the borrower regarding the true interest cost of the credit. The aim of such a practice is to give consumers the benefit of assessing the true interest cost of potential loans with the aim of deciding whether the terms are acceptable.

The disclosures do not end at the initial stage of obtaining the loan because any proposed changes to the true interest costs for that loan must be disclosed to the borrower reasonably well ahead of time. Some lenders also go as far as including reminders or pointers to the true interest cost of the loan on billing statements sent to the borrower each billing cycle. Another reason why it is necessary for lenders to disclose true interest cost information to potential borrowers is because some of them do not totally understand the meaning of the type of loan they are trying to obtain. An example of this can be seen in the case of a potential borrower who is trying to obtain a specific type of mortgage without really understanding the terms.

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