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Viewpoint 006
The ADD-ON RATE Hoax
By Ved Seereeram.

Over the holiday season I visited a shopping mall with a banker friend of mine. He found the prices of items super attractive. Brand name shirts were advertised for $100. He spent time choosing a shirt from the wide selection and at the cashier he was shocked when he was asked to pay $200. He insisted that there was some mistake as he only had to pay $100 as advertised by the sign at the entrance. The cashier asked my friend if he had read the fine print. Perplexed, my friend asked “what fine print”? The cashier very seriously replied “the one at the bottom of the advertisement”. The banker rushed out to read the sign and true to the cashier's word, in fine print, barely visible to the naked eye, was written “$100 was for the front of the shirt; add another $100 for the back”. 

Very angry about the incident he abandoned the purchase, threatening the store owner to report the matter to the Ministry of Consumer Affairs.  
Poor fellow, he was so furious about the deception, that he almost in a second reversed the longevity promised by a recent and expensive triple by-pass heart surgery. Despite my attempt to nurture his composure, he muttered under his breath wondering how anyone could practice such deception in the open and why were the authorities doing nothing about it. The price of $200 was still a good price for the shirt; it was the unashamed deception and advertising hoax in broad day light that worried the banker. 

Time, the great healer, allowed us to have a hearty meal that evening and having settled to his normal self my banker friend (let's call him John, and any resemblance to any banker called John with triple by-pass is absolutely coincidental) agreed with my observation that sometimes incidences arise in order to make us reflect on our own actions. Having succeeded so far I ventured to suggest to John that he should not be so angry with the store owner particularly when the banks themselves are guilty of such deceptive practices.  

Having aroused his intellectual curiosity he challenged me to explain. The conversation that followed went like this: 

Ved: What does the interest rate on a loan represent?

John: The price of renting or borrowing money expressed as a cost per annum or Annual Percentage Rate (APR)

Ved: Is that similar to renting commercial property on a square foot basis per month?

John: Yes.

Ved: How important is the APR in comparing one loan offered by bank A to that offered by bank B?

John: Extremely important and in fact the only means to objectively compare the loans

Ved: How do banks charge for commercial loans and mortgages?

John: The agreed interest is calculated on the reducing balance of the loan and charged to the borrower monthly.

Ved: And how do banks charge for consumer loans?

John: We use an add-on rate

Ved: Can you give an example

John: Sure. If a customer wants to borrow $10,000 for three years we simply multiply the $10,000 principal by the current add-on rate of 6% and multiply the results by 3 representing the number of years over which the loan is to be repaid. These calculations amount to $1,800 which is then added to the principal of $10,000 and divided by 36 to arrive at a monthly payment of $327.78.

Ved: But John, the 6% is charged on the full $10,000 amount for 36 months when in fact the customer will begin repaying the principal from the first month and will not have the use of the $10,000 for the full 36 month period.

John: Well, I see your point. It is true he is being charged on the full $10,000 for 36 months as if no principal payments were being made.

Ved: What is the true Annual Percentage Rate or cost of funds to the borrower?

John: More like 11%

Ved: John, glad you are still in a good mood. Do you agree that the advertised rate must represent the cost of borrowing?

John: Yes, sure

Ved: Do you agree that the advertised rate of 6% is deceptive and misleading?

John: Hmmmmm.

Ved: Do You agree that for a reputable industry to advertise a 11% loan as 6% is perhaps more unforgiving than a small merchant advertising a $200 shirt for $100?

John: Did we order dessert?

Ved: Yes we did. Just answer a last question. Do consumers of retail loans have a right to be angry at the banks persistent deceptive practices?

John: What dessert did we order?  

Obviously the incident with the shirt merchant was not real but the one with the banking industry is real and kicking. Should any store owner try such deceptive advertising they would very soon feel the wrath of the public and would have to change their practices with great haste in order to stay in business. The banking industry is perhaps the only industry that could advertise the cost of loans at half the real price and get away with such deception. Year on year the deception is intensifying and a passing reference to the fine print do not in any way legitimize the wrong.  

To even entertain the thought that consumers only understand the add-on rate calculation is an insult to our intelligence and a brutal assault on the high literacy index ascribed to the citizens of Trinidad and Tobago . If by now the industry cannot educate the users of its services to understand a simple mortgage type loan then we are beyond hope where consumers will be perpetually taken advantaged of. Should all business adopt the banks unsavory behavior then as consumers and buyers of apples to zebras we would have to continually double the advertised price in order to conclude a purchase or alternatively we would soon get double vision from the agonizing task of perpetually reading fine print.

In all fairness to the present crop of young and eager banking executives, they inherited the hoax and no doubt they will be anxious to address this unethical and unlawful practice before the next silly season for consumer lending arrives. The add-on rate is no doubt the bunny rate of consumer lending where the banks continue to charge add-on interest on loans already repaid. Why should anyone be charged rent on property already surrendered?  

The add-on rate has no relevance to the cost of financing and must be immediately discarded from the financial landscape.

All the lending officers who have been trained in the deception of add-on rate calculations should be given their little add-on rate booklets as mementoes. Such instructions do not belong to the modern banking era. Instead the officers should all be given the booklet on mortgages which is more truthful and accurate. 

Hopefully, the banks would look at the facts and immediately resolve for the New Year, before the time for New Years resolutions expire, to abandon the add-on rate application for the honest and true simple interest calculations. That would be a wonderful gift to the nation for 2003 and would represent a giant step in the coming of age of the banking sector.