Personal Loans: Understand the Real Cost Beyond the Nominal Rate
Taking out a personal loan today can mean repaying between 43% and over 160% more than the original principal within a year, depending on the lender, the borrower’s profile and associated costs. This significant difference between the borrowed amount and the total repayment highlights the importance of looking beyond just the advertised interest rate.
Understanding the True Cost of Borrowing
Banks and fintech companies typically advertise the Nominal Annual Rate (TNA). However, this figure doesn’t account for the compounding of interest or all the costs associated with the loan. The Effective Annual Rate (TEA), does consider the periodic accumulation of interest.
For example, a TNA of 47% annually equates to roughly a 3.9% monthly rate. But because interest is calculated and added monthly, the TEA exceeds 58% by the end of the year. The actual cost of borrowing is therefore higher than the initially published nominal rate. Adding to this is the Total Financial Cost (CFT), which includes insurance, administrative fees, and taxes – the true indicator of the total amount repaid.
According to data from the Central Bank, the average rate for personal loans in the first two weeks of February ranged between 67% and 72% nominal annually, with projected inflation between 20% and 30% annually. While price increases have slowed compared to previous years, consumer credit remains expensive.
Disparities in Lending Rates
Significant variations exist within this average. Borrowing from a traditional bank with a payroll account differs considerably from using a digital wallet. A simulation on a digital platform showed that a $550,000 loan repaid in 12 installments of approximately $81,000 would result in a total repayment of nearly $972,000 – almost double the original amount. The total cost of financing exceeds 100% annually, as the financed amount decreases each month before full repayment.
Differences also exist *within* banks. For a $1,000,000 loan, one institution reported a TNA of 86%, a TEA of 129%, and a Total Financial Cost of 171.22%. In other words the effective cost of financing is more than five times the projected annual inflation rate.
Other traditional institutions vary interest rates based on the applicant’s profile. Official entities offer rates starting around 42% nominal annually for clients with a strong relationship, while others range widely between 45% and 85% nominal annually, depending on service packages and direct deposit of salary or retirement funds.
“The rate depends on the credit profile, the amount requested, the term, and the level of risk assessed by the bank. It’s not the same for a client with a payroll account and good history as someone without a background or with variable income,” said Juan Pablo Perojo, CEO of PMP Contabilidad & Consultoría, to Infobae.
Perojo also cautioned that the Nominal Annual Rate is not the determining factor, but rather the Total Financial Cost. “Many times, the client focuses on the nominal rate because it’s the first number they see, but the CFT shows the real impact of the credit on income,” he explained.
Amortization and Hidden Costs
The structure of rates is further complicated by how installments are calculated. Most personal loans use the French amortization system, which establishes a constant installment throughout the loan’s life. However, the internal composition changes: initially, a larger proportion of the payment goes towards interest, and less towards principal; towards the end, this reverses.
For loans that levy IVA (Value Added Tax) on interest, the total installment may even decrease slightly, as the tax amount diminishes as the interest component declines. In a lower inflation environment than in previous years, a direct comparison between the rate and inflation can be misleading. “Interest rates incorporate much more than expected inflation. They also include the risk of default, the cost of funding, the tax burden, and the macroeconomic context. When the risk of default increases, credit becomes more expensive,” Perojo explained.
Current interest rates demonstrate that, despite slowing inflation, consumer financing still operates with high-risk parameters. In real terms, borrowing continues to be costly and doesn’t necessarily offer a way to “beat” inflation.
Beyond the interest rate, Perojo emphasizes that the decision to borrow should be tied to the use of funds. “A personal loan can make sense when used to consolidate more expensive debts, finance a necessary investment, or cover an emergency. The problem arises when it’s taken for current expenses or consumption that doesn’t generate any return,” he said.
The analyst recommended evaluating not only the Total Financial Cost but also the impact of the installment on monthly income. “The key is that the commitment is sustainable over time. If the installment represents a very high percentage of the salary, any unforeseen event can disrupt personal finances,” he added.
Before signing a loan agreement, it’s necessary to request a detailed breakdown of the total amount to be repaid, compare alternatives between institutions, and accurately calculate how much the installment will represent within the family budget. In a context where interest rates remain high in real terms, preliminary analysis is as important as the need for financing.
Frequently Asked Questions
What is the difference between TNA and TEA?
The Tasa Nominal Anual (TNA) or Nominal Annual Rate doesn’t reflect the effect of compounding interest or all costs linked to the credit. The Tasa Efectiva Anual (TEA) or Effective Annual Rate, however, does contemplate the periodic accumulation of interest.
What is the Costo Financiero Total (CFT)?
The Costo Financiero Total (CFT) or Total Financial Cost incorporates insurance, administrative expenses, and taxes, and is the indicator that truly allows you to gauge how much you will end up paying.
How does the amortization system affect loan repayments?
Most personal loans use the French amortization system, which establishes a constant installment throughout the life of the credit. However, the internal composition changes: at the beginning, a larger proportion of the payment goes towards interest, and less towards principal; towards the end, this reverses.
Considering the complexities of personal loan costs, what steps will you take to ensure you fully understand the financial implications before borrowing?