Going into debt is risky business, for both the lender and the borrower. The lender may not be sure if they’ll be paid back. If they think you’re more of a risk, they charge you higher interest. There’s more on how that works below.
As a borrower, your risk is that the loan may seem like a good deal to you, but your circumstances could change, leaving you unable to repay. Or a critical emergency might crop up, so you have to pay for that instead of repaying your loan.
You can be a smart borrower by knowing what you’re signing up for, reading the fine print of your credit contract, and having an emergency fund at the ready if anything goes pear shaped. You’ll want to make sure you have a good plan in place to pay back the money you’re borrowing.
How interest works when you borrow
When you take out a loan or use credit, the price you pay for using other people’s money over time is charged in fees and interest.
There can be all sorts of fees when you borrow: setup fees, annual fees, late fees, default fees (a penalty if you miss payments).
- While Buy Now, Pay Later companies like Afterpay, Laybuy or Zip don’t charge you interest, they have late fees if you miss your instalments. (They mostly earn their money by charging retailers.)
Your credit contract sets out the fees involved in your loan (it’s typically in the fine print).
Interest is what you pay for borrowing – the cost of money over time. It’s typically represented as an annualised percentage rate (you’ll see it called an ‘APR’ in the fine print). It’s how much you’d pay over a given year for each $100 borrowed.
Because interest is shown in percentages, these can seem like minuscule numbers not worth paying attention to, but those tiny figures can cost you thousands, even tens of thousands of dollars. Here are some typical interest rates:
- Payday loans: 49.99%
- Store cards: 25.99%
- Credit cards: 19.95%
- Personal loans (including debt consolidation): 12.90%
- Car loans: 13.95%
- Mortgages: 7.34%
You can easily see which type of loan is most expensive from those rates, but how much you end up being charged depends on how long you take to repay. The longer your debt goes on for, the more it costs you. If you take on high-interest debt like a payday loan, it’s best to treat it as an emergency and get rid of it as quickly as possible!
When you borrow, you’ll find your interest rate for your particular loan on your credit contract, but you may not know if it’s a good one or not. One way to compare is at interest.co.nz, which publishes rates for credit cards, personal loans and mortgages. Rates change frequently, and comparing helps you shop around.