Mar 27, 2024 - Business

Calculating the real cost of a line of credit

Illustration of a stack of money wrapped up in a terms and conditions document.

Illustration: Aïda Amer/Axios

One part of financial literacy banks don't usually push is the ability to notice when banking products are unattractively priced.

Driving the news: Varo Bank announced on Tuesday a new product called "Varo Line of Credit," which is advertised in the neobank's app as giving customers the opportunity to borrow up to $2,000 instantly for an "affordable fee" and "0% APR."

Reality check: This is like no line of credit you have ever seen before.

  • Rather than being able to make draws on the line whenever they need to, Varo customers have to take the full amount up front — and they have to pay all the interest up front, too.
  • The repayment schedule is then fixed rather than flexible. That means borrowers can't repay the loan early to reduce its cost.

By the numbers: This "0% APR" product looks a lot like a term loan. If you calculate the APR as though it were a term loan, it comes out to 34.6%.

  • That's significantly higher than the average interest rate on credit cards, which is 21.5%.

How it works: Charging a $400 fee on a one-year $2,000 loan looks like an interest rate of 20%, not 35%. But when the $2,400 is paid down at the rate of $200 per month for 12 months, then the average amount outstanding over the course of the year is not $2,000 but rather $1,100. That makes the $400 paid in interest more expensive.

  • For the record: Varo CEO Colin Walsh says the appeal of the loan is its simple and transparent fee structure; and that the product will provide borrowers who are often overlooked by banks with access to credit.

Fun fact: It's not just folks living paycheck-to-paycheck who can get tripped up by bank fees. Variety notes that The Will And Jada Smith Family Foundation ended up paying $3,304 in bank overdraft fees in 2022.

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