4.2.5 The cost of different types of credit
- 4.2.1 How credit works
- 4.2.2 Credit options
- 4.2.3 The cost of borrowing
- 4.2.4 The effect of interest
- 4.2.5 The cost of different types of credit
- 4.2.6 Case study: Deferred payment plan
- 4.2.7 Payday loans
- 4.2.8 Tips to keep borrowing costs down
- 4.2.9 Joint borrowing
- 4.2.10 Rights and responsibilities
- 4.2.11 What to know before you sign a loan agreement
- 4.2.12 Summary of key messages
Because various types of credit have different interest rates, terms and ways of charging interest, the total cost of borrowing money using them can vary significantly.
Example: Suppose you want to buy a washer and dryer set that costs $1,000 at your local department store. You can't afford the full purchase price, so you are considering whether to use a MasterCard or Visa credit card, the store credit card, a line of credit from your bank or a rent-to-own contract.
Here's what you will pay using each of these methods:
Type of credit |
Terms |
Months of payments |
Interest rate |
Total interest |
Total amount paid |
|---|---|---|---|---|---|
| Network branded credit card (e.g., MasterCard, Visa or American Express) | Assume you make the minimum monthly payment of $40, or 4%* of purchase price | 32 | 18% | $262.70 | $1,262.70 |
| Store credit card | Assume you make the minimum monthly payment of $40, or 4% of purchase price | 38 | 28% | $518 | $1,518.00 |
| Line of credit | Interest rate is tied to the prime rate, which can change. Assume that the interest rate stays at 6% and that you make the minimum monthly payment of $40, or 4% of purchase price | 27 | 6% | $64.50 | $1,064.50 |
| Rent-to-own | 2-year contract with payments of $80/month | 24 | Works out to 72.5% | $920 | $1,920.00 |
*With credit cards, the minimum monthly payment may be up to 10 percent of the amount owing. For this example, we are using four percent.
The line of credit offers the lowest total price, while the rent-to-own contract nearly doubles the initial purchase price. Keep in mind that, with a credit card, if you pay in full by the due date, you won't pay any interest at all (except in the case of a cash advance), making that the best deal.
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