when p the number of payment periods in a year, such as 52 or 12, f=the cost of the loan in dollars, a=amount of loan, and n=number of installments.

In some instances even the relatively simple calculations shown above can be avoided by reference to published figures. Some financial agencies make what they call a flat service charge for installment loans, which is a percentage of the loan applied across the board regardless of number of installments to be paid. For example, an 8 percent flat charge on a $1,000 loan would be $80. The total ($1,080) is then divided by the number of months the payments are to run, depending upon the sum the client plans to repay monthly. If this payment is $120, the $1,000 loan will be liquidated in 9 months.

What is the relationship between this so-called flat charge and the effective interest rate? A moment's consideration will show that the relationship is through the nominal interest rate mentioned in step 3 above. In fact, the flat charge and the nominal interest rate amount to precisely the same thing. Thus by first reducing or increasing the flat or nominal rate to the simple interest rate, as already indicated, the effective rate is secured by taking steps 4 and 5.

For 12 monthly payments, the flat or nominal rate is obviously the same as the simple interest rate. For fewer payments, the flat rate is less, an in the illustration above, where the flat rate of 8 percent is equivalent to simple interest of 10% percent (8/9 X 12). For monthly payments extending over more than a year, the flat rate is more than the simple interest rate. To cover 36 monthly payments, for example, the flat rate is three times the simple rate and would therefore be even less than the effective rate. A 12 percent flat charge covering monthly payments for 3 years is equal to 4 percent simple interest and, from table II above, to a 7.8 percent effective interest rate. Other equivalents between flat and effective charges are given in the following tabulations.

TABLE III.—Comparison of flat finance rates and effective interest rates for selected repayment periods

In other borrowing situations, when the interest charge is a monthly rate, and when a new balance is calculated at the end of each month, the effective rate is the same as simple interest, and merely needs to be converted to an annual rate. A cost of 1 percent a month on each monthly balance is thus 12 percent a year. However, when the rate varies with the amount borrowed, different rates applying to each bracket, the effective rate is not so readily calculated. In Ohio, for example, the small loan law provides that 3 percent per month may be charged on the first $150, 2 percent on the excess over $150 up to $300, and percent on the excess over $300 up to $1,000. Under these rates, a loan of $600 will cost $9.50 the first month ($150×3 percent, $150×2 percent, and $300×% percent). which is at an annual rate of 19 percent ($9.50×12)÷$600.

CONSUMER FINANCE INSTITUTIONS

There are two major types of credit that involve repayment on the installment basis. One of these results from the purchase of consumer goods, most fre quently an automobile, with payments spread over a period of time. The other is a cash loan to be repaid in installments. In the majority of the first type of credit a sales finance company (either an independent or one national in scope) is used. For cash loans the most frequently used sources are small loan companies, commercial banks, and credit unions.

Actually, all types of consumer finance institutions are in competition. If an individual wishing to buy consumer durable goods on an installment basis can secure the necessary credit at a lower cost from, for example, a commercial bank, there is no reason why he cannot pay for the goods purchased with cash provided by the bank. It is this possibility of choice that makes it worthwhile for the individual to understand and to know the effective interest rates. It will be money in his pocket if he can finance his contemplated purchase at a lower net cost.

Unfortunately, no sweeping generalizations can be made to assist the individual in selecting the type of consumer finance institutions. The ability to furnish some type of security for a loan, to provide a comaker, to make a wage assignment, or to furnish character references may have some bearing on the charge that will be made. The size of the loan is also a factor, as costs for small loans may not vary greatly from costs on much larger loans.

In the Miami Valley, charges made by sales finance companies seem to be in line with prevailing rates for comparable geographical areas. Credit unions contacted charge 1 percent per month (12 percent per year) although refunds up to 10 percent are not uncommon. Small loan companies are more inclined to charge the maximums allowed under Ohio law, which is understandable considering the small size of many of their loans. Commercial banks make a simple interest charge between 6 and 8 percent, which as explained earlier, results in an effective interest rate that may or may not be higher than that charged by credit unions, depending on the method of repayment.

CONCLUSIONS

Borrowing money, whether it be an unpaid balance on an automobile or a cash loan, costs money. When the loan is repaid in installments, an announced interest rate may or may not have any bearing on the real or effective interest. The consumer, if he is wise, should compare effective interest rates and borrow from the type of institution from which he can secure funds at the lowest cost. To do this he must be willing to take the trouble to find out the real cost of the money either by asking questions or making the computation himself.

Of course, other factors may enter the picture. An individual may have savings on which interest is being earned at the rate of 2 to 4 percent a year. From a cost standpoint, it would pay him to liquidate these savings and pay cash for the expenditure he is presently financing on an installment basis. This might be unwise, however, from a "rainy day" viewpoint. For the same reason he may not care to use his ability to borrow cash from a cash-loaning institution even though he might thereby save money.

In any event, if he understands what he is doing and why he is doing it, then he may be making a wise decision. However, when he doesn't realize that installment credit can be expensive and when he doesn't ascertain the true cost of the money he is using, he is not acting prudently as a consumer.

73079 0-61-88.

Name of State

Retail installment sales acts, goods other than motor vehicles, 21 States