Revolving credit simulation
If we decide to carry out a simulation on a loan, whatever it is, it is above all to measure what will be the rate of effort to which we will have to agree to repay it. Because it is of course on the monthly payments that our gaze rests. And this monthly payment depends on several parameters; the loan rate, its repayment period, and, of course, the amount borrowed. The same goes for a revolving credit as for any other credit. Even though here we have the possibility to choose the amount of our monthly installment.
Knowing that, let's take a closer look at revolving credits . Because these are very special. Starting with their rates. For the same amount borrowed, a revolving loan can prove to be both much cheaper and much more expensive than a depreciable loan. Simply because of the repayment period. There is no prepayment penalty on a cash reserve. It is even one of the basic principles of this type of product; be able to reimburse in full when we see fit.
So, for an equivalent amount, if we choose a very high term, the repayment will be quick, and will not cost much in interest. But if we go for a low monthly payment, in order to preserve our monthly budget, then the cost will skyrocket. The repayment schedule will be longer the lower the monthly payment.
Because a small calculation will always be clearer than a long speech, let's take a concrete example. Let's apply for a $ 6,000 envelope on revolving credit. And let's spend $ 1,250 right now. Let's see what the simulation gives.
Before going any further, know that the new provisions in force since the implementation of the Lagarde laws consider that a revolving credit must be repaid within a maximum period of three years if the amount borrowed is less than $ 3,000. This is the case in our example.
If we choose for the lowest possible monthly payment, that is, the one that gives us 36 months to repay, we get this:
A monthly payment of nearly $ 52, for a total cost of credit of nearly $ 600. In capital / interest ratio, this gives us a fractional monthly payment as follows: $ 34 of principal repaid, for $ 18 devoted to interest and loan insurance. But the most important figure is the total cost of credit. As you can see, by taking our time, so as not to strain our monthly budget, we reach a total cost of almost 50% of the value borrowed!
For comparison, let's double our monthly deadline:
For $ 104 monthly, we reimburse in 15 months. But the most important observation to make is here: Of these 104th monthly payments, only $ 20 is devoted to interest and insurance. This is due to the method of calculating repayments of renewable credits. The amount of interest is almost fixed, regardless of the amount of the monthly payment. So that a low monthly payment drastically increases the cost. In fact, the tighter our budget, the lower our maturity, and the more we pay… In this second example, the total cost of interest and insurance amounts to less than 20% of the amount borrowed.
In fact, the rates ultimately do not matter. It is the repayment term that will cost your loan. And this is where revolving credits can turn out to be traps. This is why, moreover, the Lagarde law package provides that for any sum greater than $ 1,000, an advisor must be able to offer a depreciable loan, in order to establish a comparison in repayments.