Well, we need to calculate the Effective Cost of Debt (ECD) to answer that. In thinking about the ECD, we want to think in terms of solving for the interest rate in an annuity calculation. The nominal interest rate, in this case 5.5%, doesn’t account for the origination fee or the 2.0% prepayment penalty you expect to incur. So we approach this just like any other annuity calculation. Using either a financial calculator or Excel, simply plug in the future value of the unpaid balance + prepayment penalty, the time of repayment of the loan, the payments made according to the promissory note, and the real present value of the loan (which is the face amount of the loan less the origination fee – aka the amount actually funded). Let’s take a look:
This paper examines the debt repayment behavior of consumers and can thus shed light on the indicators of consumer debt repayment and the relevance of SMS reminders in debt collection.
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Typically, an accountcan experience a series of events throughout the course of the debt recovery process,such as payment commencement, missing a payment, settlement, etc.
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The study found out that the popular debt collectionstrategies that are employed by the councils are, subcontracting of debt collection to third partyagents that work on commission and this is also supplemented by use of internal debt collectionunit in the councils, adoption of both enforcement and proactive debt collection strategies.
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The study found that the subcontracting of thedebt collection to third parties and the enforcement strategies had a positive relationship with thelevel of debts while pro active debt collection strategies and the use of internal debt collectionunits were found to have a negative relationship with the level of debt collection in the councils.
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The Effective Cost of Debt, on the other hand, is nominal interest PLUS all other expenses that might be incurred by the borrower. Common examples of such expenses besides the interest that one pays on a loan are up-front fees like pre-paid interest and prepayment penalties. The promissory note you sign may state a certain interest rate, but any other payment you make in addition to the interest payments as spelled out in the amortization table changes the Effective Cost of Debt.
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Why is it so important to calculate and be mindful of the Effective Cost of Debt (ECD), besides having a penchant for accuracy? Because after calculating in all the costs of borrowing money, what looked like a positive leverage investment at the nominal rate of interest may become a investment. That is, you may be paying more to borrow money than the yield on the investment into which you intend to invest the borrowed money – the financial equivalent of taking one step forward and two steps back. Another illustrative analog is of a credit card company paying a collection agency more to collect a debt than the value of the debt itself.