What Loan Really Costs to Customers?

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Table of Contents

Introduction
What Loan Really Costs to Customers
Adjustable-Rate Mortgages and Borrowing Practices
References

Introduction

Unless one is considering an interest free loan, there are costs that are associated with taking a loan. This fact is, however, often overlooked when one is compelled by circumstances to take a loan from an interest charging institution such as a bank. What most financial institutions will not tell their customers is that there are hidden costs that they should be aware of. For this and other reasons, it is advisable for a borrower to take his or her time to seek input from a financial expert before agreeing to any loan contract.

According to Coronato and Coronato (2008), it is vital for every good lender to issue the borrower with a good-faith estimate once a loan application is received. Good-faith estimate refers to details about the loan that are communicated to the borrower by the lender through a commitment letter. Among other things, it contains the loan terms and anticipated costs.

What Loan Really Costs to Customers

There are a number of factors that go into figuring out the full cost of a loan. One of the obvious factors to be considered is the interest rate to be paid by a customer. To protect consumers from any form of exploitation, Congress passed the Consumer Credit Protection Act in 1968 (Ehrhardt & Brigham (2014). The Truth in Lending provisions in the Act require banks as well as other lenders to disclose important information about loans such as the annual percentage rate (APR) being charged. Other costs that a consumer must be made aware of include lender fees, attorney fees, and state fees (Coronato & Coronato, 2008). It is also possible that specific lenders may have additional charges that must be clearly understood by the borrower.

Adjustable-Rate Mortgages and Borrowing Practices

Drawing from a study by Galaty, Allaway, and Kyle (2001), adjustable-rate mortgage (ARM) is usually originated at one rate of interest. The rate then fluctuates up or down during the loan term based on the prevailing market indicators. As a result of changes in interest rate, the mortgagers repayments may also change. ARM is known to feature a lower rate of interest during the early days of a loan and this may benefit borrowers to a certain extent. In some cases, borrowers are also likely to benefit whenever interest rates fall. In addition, it offers borrowers a cheaper option to purchase a home and still be able to save. Despite these advantages, there is a very high level of uncertainty associated with ARM. In a worst-case scenario, the interest rate may increase significantly forcing the borrower to pay the lender so much interest.

While it offers some advantages, I would be hesitant to go for ARM. Borrowers should be extremely cautious before engaging in an ARM contract. To be on the safe side, it is imperative for a borrower to receive proper guidance from a financial expert in order to determine whether it is appropriate to get into such a contract. Among other things, the knowledge that interest rates can change creates anxiety and may seriously affect an individual’s ability to plan well for his or her future. For these reasons, borrowers should try to avoid ARM as much as possible. Only when no other better alternative exists should a borrower be advised to engage in an ARM contract.

References

Coronato, T. E & Coronato, H. (2008). The Only Real Estate Investing Book you’ll ever need: Identify the Opportunities Know the Risk Profit in Any Market. Avon, MA: Adams Media.

Ehrhardt, M. C. & Brigham, E. F. (2014). Management: Theory and Practice (14^th ed.). Mason, OH: Cengage Learning.

Galaty, F. W., Allaway, W. J. & Kyle, R. C. (2001). Modern Real Estate Practice in Ohio. Dearborn, MI: Dearborn Real Estate.

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