In the UK, the term “APR” is defined by the Consumer Credit Act 1974 to mean (roughly speaking) the true mathematical (compounded) annual interest rate, rounded to one decimal place.

In the US, “APR” is defined by the Truth in Lending Act 1968 to mean (again, roughly speaking) the periodic interest rate multiplied by the number of periods in a year.

The purpose of each law is to make interest rates easily comparable between financial products, and I suppose this works within each jurisdiction (but in the US it only helps you compare products with the same number of compounding periods in a year). But it makes for a lot of confusion in transatlantic discussions.

In fact, the internal rate of return of this specific installment plan is found via an iterative process and is a monthly rate of 2.92285% (just to be precise), easily found with any financial calculator.

However I firmly believe that it’s wrong to multiply that number by 12 to come up with a yearly APR that comes to about 35.07%. In fact, if we’re talking about converting monthly rates to an annual rate then we should think about monthly compounding. The mathematics of such compounding will make the annual rate even more than the advertised 35%. It’s obtained by adding 1 to the monthly percentage rate and taking its 12th power.

Which makes the yearly rate worse than the advertised APR: A whooping 41.3%, to be more precise.

It is a profitable business indeed…

There are many others who are misled into believing that they are paying lower interest rates in other countries on installment plans such as those, and the bank in this case will quote a montly rate of 1.67% (20 divided by 12) as opposed to 2.9% that is found via time value of money calculations.

I am John Hope Bryant, the individual you refer to from the panel. Thanks for your passion sir.

Thank you also for coming to the first ever panel hosted by the Milken Global Conference, and frankly, it sounds like maybe you should have been on it, for some lively debate.

Here are a few important clarifications:

1. The panel was 1 hour and 15 minutes total. Very challenging to tailor make the conversation you desire, in a discussion even twice as long. In an hour, in a first ever panel, a thoughtful “40,000 feet” conversation with 5 panelists is unfortunately just about pushing the envelope of the possible. This said, I was surprised we did not hear from you during the Q & A period, given your strong views. Would have been happy to respond there, but nonetheless let me respond here.

2. As a meaningful point of reference, you should know that I am not just an advocate for financial literacy. I am the founder of Operation HOPE, which has reached, teached and empowered more than one million low-wealth individuals in practical, asipirationally relevant financial literacy since the L.A. riots of 1992. Today we are the largest urban delivery system in America, operating in 68 urban communities, and 6 provinces in South Africa. As a nonprofit we have funded more than $300 million in new homeownership from HOPE(loans that did repay), and subsequently have additionally restructured more than $250 million in existing mortgage loans, from other lenders, tied to this subprime mess. Half of the restructures are middle class borrowers and about half are low-wealth. Check out results for yourself at http://www.operationhope.org.

3. The work of HOPE directly inspired our government to make financial literacy federal US policy, which subsequently created the President’s Council, where I serve as vice chairman, and chairman on the Committee on the Under-Served. Mr. Salmon, I had been pushing this issue for 7 years with then President Bush, but it did not actually happen until 2008. That said, our President’s Council annual report has already produced legislative bills from Congress requiring financial literacy in schools, and college (see HR 1325 by Congresswoman Sheila Jackson-Lee, requiring anyone receiving a guaranteed student loan to also be required to take a 4 hour course in financial literacy, and all colleges and universities receiving federal funds would be required to offer a course in financial literacy). The non-partisan Council has enjoyed support from the Obama Administration, and I think President Obama will ultimately make this real in real people’s lives (including his meetings recently with credit card companies at the White House). In other words, progress is a process. A passionate process, but a process nonetheless.

4. Our work at HOPE has increased credit scores from 570 to 670, in our HOPE Centers. That moves someone from predatory lenders to mainstream bankng. That is real.
5. Here is the real point of the last two; we know a thing or two about how this impacts people’s lives on-the-ground and in real time;

5(a). With all the challenges with credit cards, and while there are MANY, they are also not the devil, and a lot better option I might add than what I call “ghettoized financial services”– payday loan lenders, check cashers, rent to own stores, and others in this $10 billion industry. Take away credit cards and the next ladder down is not pretty at all. Credit cards ARE or can be a lifeline for homeowners, and we need to work to make them (credit card providers)work better for people. I might add that I also noted in my remarks that I had personal frustrations with my own credit card providers, and yet we should not throw the baby out with the bathwater.

5(b). My mentor is Andrew Young, and Young and his friend Dr. Martin Luther King, Jr were optimist, and were focused on “what they were for, and not just what they were against.” Young has taught me well that you don’t get very far jamming up people you want to help you, in public no less. There has been more progress through evolution than revolution, and my job is to encourage the “better angels” of leaders within the credit card industry (and their own enlightened self interest), and more so on this panel, to hopefully “ispire” Citi Cards to take a positive lead. Beyond that, and on a personal level, David Simon is just a great American, who has volunteered regularly with me through Banking on Our Future, teaching financial literacy in classrooms throughout NYC, and encouraging his staff and the bank to do the same. Even as he left the panel is was brainstorming ideas of how he and Citi Cards could do more, even changing card terms and promoting incentives to card holders over charges. Isn’t than exactly what we want?

I guarantee you will get more real and sustainable change out of folks through a form of rational inspired leadership, based on enlightened self-interest, than you will through the simple power of coercion, jamming folks up in public forums just because you can (even one who is legally blind can see that the credit card industry is in deep trouble, and need to change. The question is, who is going to help them do precisely that).

Note: at present not one of our funding partners are credit card companies, so my comment(s)come without financial bias, though we are non-profit nonetheless.

In closing, I believe that “every good marriage is made of constructive friction,” so I encourage you to keep pushing me and others to “do more.”

Respectfully —

The reality is that 95% of people spend everything they have up to some liquidity constraint. If you prepay your debts you feel poorer and spend less.

The extra money that went to the mortgage company while I was still paying off the mortgage was matched almost 1-to-1 by less spending, not by a reduction in other assets.

Most financial advisers would claim I lost a few % points of return because of the tax benefits for mortgages. I think these people are idiots.

I think my net worth is much higher now than it would have been if I had listened to them.

In this respect, greater financial literacy on the part of the consuming public would run counter to the banks’ interests – hence I don’t expect much push on their part to develop it. I concur with the main point that financial literacy means more than present value computation, it means an intuitive understanding of the consequences of financial actions and the potential benefits and risks involved.

But I also concur with William Bernstein, who came to the reluctant conclusion midway through this decade that the general public is too unsophisticated to handle self directed retirement savings. There’s a base level of financial literacy, and an advanced one, and most folks struggle with the basics.

Thank you for bring this to the forefront. For more information about financial education that TRULY supports clients seek organizations in your local communities that offer IDA programs (www.idanetwork.org) or visit http://www.sfearn.org to learn more about financial coaching.

First, let me note that I understand the time value of money and its use in valuing investments and cash flows and all that stuff.

However.

Those who comment on this blog post likely will overestimate the sophistication of the average person about whom Felix is blogging. These are people for whom the concept of the time value of money is an abstract artifice. If I were financially unsophisticated I would think I’d want to know that I owe $100 every month for 12 months than to ponder the fact that I owe a lump sum of $1200 12 months hence: that is too amorphous and too large a sum to contemplate in the future and so I’d likely default on the loan.

The distinction here is between the theoretical treatment (the time value of money) and the quotidian realities of people’s financial illiteracy.

Even though I’m finally literate enough that I got the question right (never mind that [iv] is a better answer since the discount rate could be zero), I cannot for the life of me understand how you came up with a 35% APR on the payment plan. Could you explain?

By a 35% APR, I’m assuming you mean that the FV in 1 year of the installment payments is $1350, as compared to $1200 under the 20% rate alternative. You’d need a really high discount rate for that; something like 28.57% if I did my math correctly.

Huh? Either way you pay $1200. So the second option is clearly better as long as interest rates are greater than 0.