How to choose a convenient loan

“Convenient loan: which one and why, “Who should I contact?”, “What if I don’t want insurance?”: after 14 years in banks, banking groups and the like, you automatically become the trusted consultant for relatives and friends who ask you about the most diverse financial issues. One of the most complicated questions that can happen is whether a loan is cheaper than another.

With its constant instalment, the loan has a simple and reassuring appearance, which leaves nothing to be desired about the underlying complexity.

Just do a Google search and you’ll come across lists of 3 (or 5, or 6) tips on how to choose loans with questionable content, such as increasing the duration of the loan to make it more sustainable. As we will see, it’s not easy to find your way around the various criteria for comparing a loan, but longer loans cost the consumer a lot more and need to be considered carefully.

For some years now, the parliaments of European countries have adopted uniform rules on the information to be provided when choosing a loan. It is mandatory to always show three indices for comparison:

  • the annual net rate (NRY)
  • the annual percentage rate of charge (APR)
  • the total amount due.

At this point, the classic article of the type “5 reasons on how to choose a loan” says that all the criteria are important but the APR is the best because it takes into account all the components of expenditure.

We, on the other hand, go against the tide and say, first of all, that a rule that imposes 3 selection criteria on consumers is not in their interest but only increases confusion. Anyone who has thought of the names of the indicators should also take a course in communication.

As for the three criteria, one is superfluous, one is misleading and only one is really useful. And it is not the APR.

Obviously, this is our opinion and we recommend comparing several before deciding.

Bearing in mind that all those who write about loans on the Internet have some kind of interest, like us, who manage a marketplace of loans between private individuals.

Before we go into detail on what to look at to evaluate its convenience, we must make a brief introduction on the operation of a loan. A little bit to clarify the following concepts and a little bit to make Google happy, which stands to a piece of blog like a traditional publisher to a book: it gives you advice that it is better to follow, if you want someone to read you.

For readers who already know what a loan is or don’t want to go into details, we simply suggest to skip the paragraph.

Convenient loan? First we dust off how a loan works

All loans offered on the Italian market are at a fixed annual nominal rate and a constant monthly instalment. This means that each month the same amount is paid back, the monthly instalment, which is composed of

  • interest calculated as a fixed percentage (the nominal annual rate)
  • repayment of the financed capital.

Since the capital falls a little every month, the interest payable falls accordingly. The constant instalment therefore hides interest that is constantly falling and ever-increasing repayment of principal. This is the magic of the constant or French-style amortisation plan.

The elements that impact on the installment of each loan are therefore:

  • the financed capital (the sum borrowed)
  • the duration
  • the nominal annual rate

The end? Unfortunately no, there is another item to keep in mind, other fees and commissions to be paid.

And that’s what makes it difficult to compare the various loans.

Convenient loan = lowest installment?

The first thing we all look at in a loan is the installment, which is how much the loan will cost each month. That’s right, because the first question to ask is whether a loan is sustainable compared to the monthly income. If it is not, the best way to ease the burden is to increase the duration, which allows you to lower the installment.

Looking only at the instalment, however, is not enough to judge the convenience of a loan or to compare different loans.

First of all, the instalment does not necessarily include all the commissions: for example, some operators charge an initial commission separate from the instalment, while others (almost all in truth) add some expenses to each instalment, such as those of collection.

Even in loans like the Soisy ones, where the instalment includes all the expenses, there is a problem: as the duration of the loan increases, it is true that the instalment is always smaller and more sustainable, but the overall expense increases: as it is logical, if I borrow money for more time, I pay more interest.

Increasing the duration to improve sustainability therefore has a cost and evaluating a loan only on the basis of the installment does not give a real idea of the expenditure.

The superfluous, the misleading, the useful

Let us return to the indicators required by the regulations: TAN, APR, total amount due.

The TAN is the percentage rate at which the loan is made (in the case of loans between private individuals is the rate that our investors receive each month). It would be sufficient to look at it if the loans had no other cost beyond the interest rate; however, since all the loans have some kind of expense or commission, it alone says nothing. It’s useless and we can forget about it.

The APR instead corrects the defect of the TAN because it is the rate that includes all the ancillary expenses and is sophisticated enough to “weigh” them differently depending on when they are paid. Noble intent. However, in most cases these costs are incurred at the beginning of the loan and are spread over the entire duration in the calculation of the APR.

This means that as the duration increases, the APR falls, giving the illusion of a cheaper loan. But as we have already seen in the case of the instalment, this is not the case. On the contrary, as the term increases, the interest payable and hence the expenditure increases. This indicator is not only useless, it is also misleading.

The total amount due, on the other hand, has none of these defects. As the name suggests, it includes all the amounts that have to be repaid for interest, principal repayment or other reasons. Compared to the APR it has the defect of not weighing the time structure of flows, i.e. it does not make any difference depending on when a certain amount is paid.

It is therefore a crude indicator, compared to the APR it is somewhat the criterion of the farmer from the large shoes and the brain up. Brain up because since it includes all the expenses it provides an exact and very concrete metric of how much will cost exactly a loan.

Purists will argue that not considering the time structure of flows is serious, but since loans tend to have similar structures and that any comparison is made difficult by the lack of a discount rate to us this seems a minor flaw.