Borrowing Money: Understanding How The Numbers Work

I would like to start out by telling you a true story. The

names have been changed to protect the innocent, the

ignorant and the dishonest.

John was interested in purchasing a new truck. John had

done his homework and knew exactly what make, model

and features he wanted on his new truck. He had visited

several dealerships looking for the exact truck he wanted.

He wanted to get it now and didn't want to wait to have

one custom built.

Finally he found a dealership that had the exact truck he

was looking for and he even liked the color.

Now it was time to negotiate the price and financing. John

realized that he was not very good at numbers so he asked

his friend Cindy to come along and help him make sure he

was getting a good deal.

The salesperson looked up the pricing information on the

truck and added in all the extra fees for tax, title, license,

and what-ever-else-we-can-sneak-by-you. The total cost

came out to about $22,000.

Cindy remained quiet while the salesperson explained the

financing options that were available to John, checked

John's credit and determined an interest rate for the loan.

The salesperson then went to check with the manger to

make sure the financing application was completed properly

and to calculate the monthly payment.

The salesperson returned and announced that the

payments on the 5 year loan would be about $420 a

month. Cindy checked the numbers and agreed with the

calculations. But John was a little shocked and

disappointed.

Seeing his expression, the salesperson mentioned that the

monthly payment may be more than what John would feel

comfortable with and that maybe they could lower the

payment by going to a 6 year loan instead.

John then looked to Cindy, who said that this would lower

the monthly payment but John would end up paying more

interest because of the longer time for the loan to be paid

off. John wasn't too concerned about paying a little extra as

long as he could afford the monthly payments (and drive his

truck home today).

The salesperson asked John how much he could afford to

pay each month on his truck loan. John indicated he could

pay up to $375 per month. The salesperson then went to

"get approval" from the manager to extend the length of

the loan and to recalculate the monthly payment.

Upon returning the salesperson announced that he was

able to "wrangle a good deal out of the manager" and was

able to get the monthly payments down to, you guessed it,

$375. John was excited. All he had to do was sign the

papers and he could drive home with his new truck at a

monthly payment he could afford.

But Cindy was curious. She asked to look at the numbers

but this time the salesperson was a bit hesitant. The

salesperson tried to change the subject one or two times,

but Cindy insisted on seeing the numbers.

Cindy review the numbers and did some of her own

calculations and found that the monthly payment on the

truck loan should have been about $350 a month. So how

did the salesperson come up with $375 per month?

After looking at the terms of the contract a bit closer, Cindy

noticed that the price of the truck was now $24,500, an

increase of $2,500. Cindy asked the salesperson why the

price of the truck had just gone up? After trying to dodge

the question and then blaming it on a mistake by the

"finance department," Cindy and John walked out of the

dishonest dealership.

As excited as he was to have his new truck, John was

angered that the salesperson/dealership had tried to rip

him off by taking advantage of his lack of understanding

how the numbers in a loan relate.

John then had Cindy explain to him in basic terms how the

number related and what to look for in the financing terms.

Cindy explained that there are four elements to a loan; the

principal or amount you are borrowing, the interest rate,

the time period and the monthly (or weekly, bi-weekly, etc.)

payment.

And the numbers relate like this. If the amount goes up the

payment goes up. If the interest rate goes up the payment

goes up. If the time goes up the payment goes down.

So in the case of John's truck loan they extended the time

so that the payment would go down. But the payment went

down further than what John was willing to pay. So they

decided to increase the amount so that the payment would

match what John said he could pay.

But they "forgot" to explain to John that the price went up

to make the payment hit his target. And they couldn't come

up with a valid reason for the price increase when Cindy

questioned them on it.

Without Cindy and her knowledge of how the loan numbers

relate, John probably would have got his truck, but he

would have needlessly over-paid $2,500.

John found a truck he liked even better at a different

dealership, bought Cindy along to help make sure he was

getting a good deal, and then took her out to dinner.

This article is free for republishing
Source: http://www.articlealley.com/article_125615_19.html