The Cost of Credit
Credit lets you take something home now and pay for it later. The catch is that the lender charges interest on the money you borrowed, so the total you repay is always more than the price on the tag. The cost of credit is that extra amount — what the convenience of paying later actually costs you.
The math is short: find the total of all the payments, then compare it to the cash price. Two multiplications and a subtraction settle every credit question, including the sneaky ones where a small monthly payment hides a big total.
Total repaid, then compare
A credit plan is usually described by a monthly payment and a number of months. The total repaid is the payment times the months: .
The cost of the credit is what's left after you take out the price: . If a TV costs $480 and the plan is $44 a month for 12 months, the total repaid is , so the credit costs — $48 for the privilege of paying later.
Some plans state an interest rate instead of a monthly payment. Then find the interest with and add it to the price: . Either way, the goal is the same number — the true total.
The small-payment trap
A smaller monthly payment is not automatically the cheaper plan. Stretching the payments over more months usually adds more interest, so the small-payment plan can cost more in total.
Compare $90 a month for 12 months against $60 a month for 20 months. The first totals . The second totals . The plan with the smaller payment costs $120 more. Never compare monthly payments — always compare totals.
The cheapest option of all is usually to save first and pay cash. You skip the interest entirely, so cash costs less than any credit plan for the same item.
Worked examples
Example 1: total repaid on a credit plan
On a credit plan you pay $35 a month for 24 months. What is the total amount you repay?
Answer: You repay $840 in all.
Example 2: the extra cost of credit
A guitar costs $540 cash. On a store credit plan you pay $25 a month for 24 months. How much extra do you pay by using the credit plan?
Answer: The credit plan costs $60 extra.
Example 3: a plan described by its interest rate
A $600 TV is financed at 10% simple interest for 1 year. Find the total repaid and the monthly payment for 12 months.
Answer: You repay $660 in all — $55 a month.
Try one yourself
Common questions
Why is the total repaid more than the price?
Because the lender charges interest on the money you borrowed. The price pays for the item; the interest pays for borrowing. Together they make the total repaid, which is always more than the price alone.
Is the plan with the smaller monthly payment cheaper?
Not necessarily — and usually not. A smaller payment stretched over more months often adds up to a bigger total. Multiply each plan's payment by its own number of months and compare the totals, never the payments.
What exactly is the cost of credit?
The extra amount beyond the price: . It is the interest you pay for taking the item home before you have finished paying for it.
When is paying cash the better deal?
Whenever you can manage it. Cash means no interest, so the total cost is just the price. Saving up first and paying cash always costs less than financing the same item on credit.
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