The True Cost of Interest

The siren cries of nothing down, easy credit and pay later have made the installment plan an essential part of the U.S. economy. In the process, consumers have run up a steadily rising personal debt of $54 billion, much of it in unpaid interest. Economists do not find the figure unduly alarming, but many of them worry that too few consumers realize the true cost of credit.

Last week in Washington U.S. Senator Paul Douglas of Illinois, an economist himself, opened hearings on his "truth in lending" bill. Democrat Douglas argues that banks often advertise a 6% annual rate on monthly-payment loans, but the actual rate is closer to 12% because the borrower pays interest on the entire amount of the loan, instead of on the steadily declining unpaid balance. Low monthly rates quoted by small loan companies and stores, notably those that cater to lower income groups, camouflage the fact, says Douglas, that the true annual interest often ranges from 18% to 42%.

Douglas would require lenders to clearly label credit merchandise with 1) the true annual interest rate in percentage terms and 2) the actual consumer cost of the credit in dollars. If a $12 dress carried a $2 credit charge over a twelve month period, the retailer would have to state the fact that the interest amounted to 17%. Says Douglas: "The consumer is his own best credit manager if he has been fully and accurately informed about the true cost of credit."

Old Habits. Douglas' Senate Subcommittee on Production and Stabilization heard anguished witnesses from the U.S. hamber of Commerce, the American Bankers Association and the American Bar Association. They protested that installment credit regulation is a matter for state and not federal control. A more candid objection to the Douglas bill came from a subcommittee member. Said Utah Republican Wallace F. Bennett, who owns a paint and household supply company as well as a Ford dealership in Salt Lake City: "The truth is that consumers have mistakenly been led to believe that 6% is the fair interest charge for credit. A statement of annual rates of 18% will be suicidal for retail merchants."

Some businessmen who support the principle of true interest disclosure dispute the methods proposed by Douglas. Among them is Sears, Roebuck & Co. Chairman Charles Kellstadt, who argues that there is a big difference between an installment-plan sale and a flat loan, and that interest charges are only a "small portion" of the total cost of extending credit (which also includes such expenses as investigations and salaries for credit office staffs). He further contends that computing interest charges on an annual basis for the popular revolving charge accounts would enormously complicate bookkeeping. This, retailers say, would increase the cost of extending credit. Kellstadt figures that unscrupulous merchants could circumvent the bill simply by burying most of the cost for extending credit in the price of the goods.

New Support. Last year a similar Douglas bill died in committee. But this year Douglas has new support--from the Kennedy Administration. Under White House pressure, the Commerce Department has reversed its stand on the bill, somewhat grudgingly favors it. Some opponents seem willing to support a softer bill. One possible compromise that they were discussing last week: a bill that would require lenders to list either the true interest rate or the total credit cost, but not both.

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