Credit is the right to put off paying for something you get now. Credit almost always costs money. When you buy a car or a living room set in installment payments, you pay more than if you bought it for cash. If you take out a loan — whether from a bank or a pawnshop — you have to pay back more than you borrowed. But how much more?
One element of the cost of credit is interest, expressed as an interest rate.
In olden times, laws limited the interest rates that various kinds of lenders could charge. Charging excessive interest is called usury. Many religious traditions still consider usury to be immoral, especially when directed at poor people. But over the past generation, as “deregulation” became national policy, laws against usury eroded. Nowadays, in most loans and sales there are no limits on interest rates and other charges! Where there are legal limits, such as in the sale of used cars, they are high. This puts the burden on us, as users of credit, to know the cost before we sign on the line.
Credit is a service that’s bought and sold. You can shop for it, just as you shop for the best price on other goods and services. The costs of credit varies depending on who is lending the money and also depending on your credit score. But it can be hard to compare different offers of credit. One car loan might be for 4 years, another for 6 years. Repayment intervals might be every week, every two weeks, or every month. In addition to interest, there may be application fees, acquisition fees, and other kinds of fees. How can you tell which is the best deal?
A federal law known as the Truth-in-Lending Act (TILA) helps you shop for credit. Enacted in 1968, it is a powerful tool to compare different offers of credit and choose the least expensive. In a marketplace where you don’t have a lot of friends, the Truth-in-Lending Act is your friend. But it only works if you use it!
TILA is a disclosure law. “Disclosure” means “telling.” TILA does not regulate how much a creditor may charge. Rather, TILA makes every extender of credit disclose its terms in a uniform format, in a timely way, so that you can compare offers of credit and choose the best buy.
A transaction is covered by TILA if it involves the extension of consumer credit by a creditor. Consumer credit means credit for your personal, family, or household use. (That is to say, this law does not apply to business or commercial transactions.) A creditor is a person or company that routinely engages in credit transactions. (That is to say, when your parents lend you money, it’s not covered.) Some transactions of more than $50,000 are not covered by TILA, but because documents are prepared by commercial printers in formats designed to comply with the law, you often get the benefit of its main disclosures in such transactions as well.
You have almost certainly encountered TILA whether you know it or not. This Sample used car contract illustrates the standard format of boxes highlighting the key terms of the transaction. In future posts I will discuss each of these, beginning with the most important terms, the Finance Charge and the Annual Percentage Rate.