Same 42% rate, twice the cost: what the interest rate doesn't tell you

Banxico’s own guide to credit has a short example that every borrower in Mexico should see. Two personal loans of 10,000 pesos. Both charge an interest rate of 42% a year. Both are repaid in 13 weekly payments, and both take an opening fee of 200 pesos.[1]

On paper they are the same loan. Banxico calculates that one costs 77.1% a year and the other 147.8%.[1] Nothing is hidden in the contract. The difference is in how the interest is charged, and an interest rate on its own won’t tell you which kind you’re being offered.

The interest rate is not the price of a loan. The CAT is.

Interest on what you owe, or on what you borrowed

In the first loan, interest is charged on the balance you still owe, which Banxico’s guide calls saldos insolutos. Each week you owe a little less, so you pay a little less interest, and the payment stays at 813.42 pesos.[1]

In the second, interest is charged on the whole original amount every week, what the guide calls interés global. You keep paying interest on money you have already paid back. The weekly payment rises to 850 pesos.[1]

Same 10,000-peso loan at 42%	Interest on what you owe	Interest on the original amount
Weekly payment	813.42	850.00
Total to pay, including the fee	10,774.48	11,250.00
CAT (real annual cost)	77.1%	147.8%

Source: Banxico, “Crédito y Costo Anual Total”.[1]

The weekly payments differ by less than 37 pesos. The real annual cost almost doubles. That’s because in a short loan, every extra peso of interest is paid within a few weeks, and the CAT measures the cost over a year.

What the CAT adds up, and what it leaves out

Banxico defines the CAT (Costo Anual Total) as a standard measure of what credit costs, expressed as an annual percentage. For information and comparison, it includes all of a loan’s costs and charges.[2] The methodology is set out in Banxico’s Circular 21/2009.[3]

According to Banxico’s guide, it counts the ordinary interest, the commissions and charges, and any insurance you are required to buy to get the loan. It also counts the difference between an item’s cash price and its price on credit.[1]

One thing it deliberately leaves out: since 17 November 2009, the CAT is calculated without VAT (IVA) on interest or commissions.[2] Advertised rates and fees must also appear without VAT, marked “Sin IVA”.[1] So if your payments include VAT, you will pay more than the CAT on the contract suggests.

What the lender has to show you

Banxico’s guide sets out what you are entitled to see before you sign:

• A cover sheet (carátula) with the CAT and the main terms of the loan, including the interest rate, the total amount to pay and the commissions. The guide’s advice is to check that it matches what you were offered.[1]
• A repayment table with the date and breakdown of every payment: how much goes to the loan itself, the interest, the VAT on that interest, any commissions or required insurance, the total for that payment, and what you still owe afterwards.[1]
• The CAT and the interest rate in annual terms in their advertising, under the transparency law for financial services (LTOSF). The same law stops lenders charging interest in advance.[1]

If the interest column in that repayment table stays the same every week while your balance falls, you are looking at interest on the original amount.

How to compare two offers

Banxico calls the CAT the most important figure for comparing what credit costs. Its advice is to compare the CAT of offers of the same type, and to also look at the size of each payment, how often you pay, the length of the loan and whether the rate is fixed or variable.[1] Then choose the lowest CAT among the loans that fit your needs and what you can afford.[1]

As a sense of scale, the same guide describes it as sound lending practice to grant a new loan only if the borrower’s debt payments are 30% or less of household income.[1]

What to ask before you sign

• “What is the CAT, and is it with or without VAT?” If the person can’t tell you, that is your answer.
• “Is the interest charged on what I owe or on the full amount?” Ask to see the repayment table.
• “What does it all add up to?” The total to pay is on the cover sheet. Put it, the number of payments and the fee into the calculator below.

The rate is what gets advertised. The CAT is what the loan costs.