A few days ago, news hit the headlines how the Central Bank of Ireland had granted a license to UK lender, Amigo Loans to operate in the Irish market.
In addition to being discussed widely across the media, it was also raised in the Dail.
What was really interesting is the reaction to the specific rate of interest; 49%.
An interest rate of 49% IS expensive. However, as some media commentators pointed out, it is not the most expensive by a long shot. Other money lenders charge far more, almost 200%. Some of those lenders use face-to-face and door-to-door lending models; and to top it all off, while highly expensive, they are also highly rated by their customers. Net promoter scores (NPS) indicate they are doing something right.
If we take astep back, what most people may not be aware of is how poorly many people across Ireland actually understand credit and what it can really cost.
Credit cards are the perfect example. Many people have one. They are one of the most ubiquitous personal finance tools used across Ireland. But what many people do not realise is how expensive they can be.
Credit cards employ a complex form of interest calculation because they are a revolving credit facility. At the foundation of their operation is compounding interest. In other words, interest is added to interest already applied to the outstanding balance.
So, if we take someone that borrows €2,000 to pay for the Christmas presents, gifts, gruband all of the other stuff that families spend money on, theirs would be a fairly typical Christmas spend.
A person with no immediate savings may choose to “max out” on the credit card where their available limit is €2,000. They now have a €2,000 debt.
With a credit card balance, borrowers have a range of options to repay it:
- They can pay off the full balance before the due date and pay no interest.
- They can pay off a specific amount each month and minimise the interest cost.
- They can make minimum repayments only where they pay the maximum interest.
With minimum repayments, there are two features. The standard minimum payment is a percentage of the outstanding balance; typically, 2.5%. However, as the outstanding balance approaches a specific level, a second minimum payment kicks in,typically this is about €5. This is an important point as it will impact the repayment of the outstanding debt significantly.
So, here is the impact of the minimum repayment on that €2,000 credit card debt.
By only making the minimum payment (2.5% / €5), that debt will take 21 years to repay and cost €2,275 in interest payment alone. Remember, the amount borrowed was €2,000 yet the total interest repaid in this case is actually greater. In other words,the total repaid is €4,275.
It is this point that most people in Ireland find confusing and which many global financial literacy surveys reveal that Irish people are so weak at grasping.
So, when it comes to Amigo Loans, or Provident or other term loan operators, yes, they are expensive but they are not the most expensive by a long-shot. People with perfect credit histories can end up paying far more to borrow. In the case of that person who borrowed €2,000 on their credit card for Christmas 2018, they can end up paying in excess of 100%.
Of course,on the flip side, if that same person paid off the full €2,000 before the due date, their credit card loan would cost them €0.
Frank Conway is a qualified financial adviser and founder of MoneyWhizz.org, the financial education initiative.