Here is some advice for life: never sign a contract full of terms you do not understand. With regard to credit, there are also some concepts that should be understood before entering into a contract. So that there is no doubt about the main terms used in the credit, we explain each of them in this article.
Interest rate = the cost of money
The interest rate is popularly known as the cost of money . In the case of a credit, it is the cost you will incur by using the bank money. We can have three types of interest rates :
- Fixed rate – A much used modality in personal credits in which the rate is fixed and unique throughout the entire contract;
- Variable rate – This modality is most used in housing credit agreements, with the cost of credit resulting from the sum and from an indexer (in Portugal we use the EURIBOR rate) and a spread.
- Mixed rate – The fixed rate modality can be contracted in housing credit contracts where there is a flat rate for a shorter period (eg 2, 5 or 10 years) and change to variable rate in the rest of the contract.
EURIBOR = the cost of money to banks
The EURIBOR is an interest rate that serves as a reference for credits in Portugal. This rate results from lending operations between the major banks in the Euro Zone and is determined for different periods (1 week, 2 weeks, 1, 2, 3, 6, 9 and 12 months). You may interpret the EURIBOR as the cost of money to the bank, the cost to you of the bank, plus a margin (which we’ll tell you about below).
Spread = the risk margin of a loan
The spread is the margin that the bank places on its cost (EURIBOR) in a credit agreement. This margin is associated with the risk of the operation and may be reduced in the event that the client is more involved with the bank.
APR = actual cost of the loan
Borrowing money from the bank involves a set of costs that does not come down to the interest rate. All credit operations have associated other costs including commissions, insurance, bank account costs or other (hence it is important to choose a bank without commissions in the current account). The APR, or Annual Effective Annual Rate, is the interest rate that aims to group together in a single indicator the amount paid. In other words, it is the real cost of the loan and it is this rate that should be used to compare different offers.
The MTIC is the total amount charged to the customer in a credit agreement. By analyzing the MTIC you will get an idea of all the costs that will be charged to you throughout the contract, assuming that the interest rate would not change. You should analyze this MTIC in parallel to the APR to compare different credit proposals.
Conclusion (and work from home)
In this article, we have left you some of the key concepts associated with a credit agreement. Knowing what each one means is your best weapon in order to get cheaper credits and make better financial decisions .
Now that you’ve been given the lesson, as a housework you will have to do different credit simulations to realize, in more practical terms, the cost of your credit. So, see what would be the cost of your personal credit and the cost of housing credit in a credit simulator.