APR vs Total Cost of Credit

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This presentation provides an overview of two ways of communicating the price of a loan: Annual Percentage Rate (APR) and Total Cost of Credit (TCC). It explains advanages and disadvantages of each, ultimately illustrating why APR is a more transparent way of communicating the cost of borrowing.

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  • Cover slide
  • Ask for raised hands. How did you decide?
  • Ask for raised hands. How did you decide?
  • Ask for raised hands. How did you decide?
  • Ask for raised hands. How did you decide?
  • Ask for raised hands. How did you decide?
  • (flat interest rate)
  • Ask for raised hands. How did you decide?
  • Ask for raised hands. How did you decide?
  • Ask for raised hands. How did you decide?
  • (declining balance)
  • Let the audience discuss
  • Cover slide
  • APR vs Total Cost of Credit

    1. 1. Promoting Transparent Pricing in the Microfinance Industry<br />APR vs Total Cost of Credit<br />June 2011<br />
    2. 2. How to measure true prices?<br />The microfinance industry is committed to measuring true prices in a consistent and transparent way so that different financial products can be accurately compared.<br />But what method should we use? There are various approaches available, each with strengths and limitations. This presentation will compare APR and TCC.<br />
    3. 3. Definitions of TCC and APR<br />
    4. 4. The Myth About APR<br />
    5. 5. The Myth About TCC<br />
    6. 6. Let’s take a Test!<br />To learn more about the strengths and weaknesses of TCC and APR, let’s try some comparisons.<br />Go thru the following quiz. <br />On each screen, compare the two options and pick the one you believe is lower cost.<br />Then click to proceed and view the answer. <br />What process did you have to go through to make your choice? <br />Did you get it right? <br />If you made the wrong choice, why?<br />
    7. 7. Which would you buy?<br />$1<br />$2<br />
    8. 8. Which would you buy?<br />$2<br />$1<br />1 liter<br />3 liters<br />
    9. 9. Processing the Results<br />Other than the price, what additional information did you need to make a decision?<br />How did you combine the different pieces of information?<br />Now let’s try some loans…. (and in these, we assume all repayment schedules are consistent, which is not true in real life!)<br />
    10. 10. Which would you buy?Example 1<br />
    11. 11. Which would you buy?Example 1<br />
    12. 12. Which would you buy?Example 2<br />
    13. 13. Which would you buy?Example 2<br />
    14. 14. Which would you buy?Example 3<br />
    15. 15. Which would you buy?Example 3<br />
    16. 16. Processing the Results<br />How did you do on the first three examples?<br />In each example, at most one of the two parameters changed – loan amount or term<br />What did you have to do to compare the TCC and determine the lower price?<br />Now we’ll see an example where both amount and term differ…<br />
    17. 17. Which would you buy?Example 4<br />
    18. 18. Which would you buy?Example 4<br />
    19. 19. Processing the Results<br />Was that a bit more difficult?<br />In all of the examples so far, does the APR give a useful answer without any additional calculation?<br />The examples so far only assume two issues – loan amount and loan term. What happens if we add other factors? Does TCC pricing get even more difficult?<br />
    20. 20. Which would you buy?<br />Example 5<br />
    21. 21. Which would you buy?<br />Example 5<br />
    22. 22. Which would you buy?<br />Example 6<br />
    23. 23. Which would you buy?<br />Example 6<br />
    24. 24. Now which?Example 7<br />
    25. 25. Now which?Example 7<br />
    26. 26. Why didn’t <br />Total Cost of Credit<br />work?<br />
    27. 27. Purchasing vs Renting<br />
    28. 28. So why do governments and textbooks use APR as a measure of true price and not “Total Cost of Credit”? <br />
    29. 29. Perception and Reality<br />
    30. 30. Perception and Reality<br />
    31. 31. Perception and Reality<br />When properly explained the APR is really quite simple!<br />
    32. 32. The Reality<br />
    33. 33. Practicing Full Disclosure<br />
    34. 34.
    35. 35. Learning More<br />You can learn more about the different approaches to measuring transparent prices at www.mftransparency.org<br />The best place to start is Session 1: Building the Foundation for Understanding Transparent Pricing(http://www.mftransparency.org/pages/category/resources/understanding-transparent-pricing/)<br />
    36. 36. Promoting Transparent Pricing <br />in the Microfinance Industry<br />

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