When you need help purchasing a high-priced item, a loan that covers the cost may seem like what you need. Before you borrow, however, it’s important to understand what a loan will cost you over time.
Understand the terms
The annual percentage rate, or APR, is a yearly percentage rate that expresses the total finance charge on a loan over its entire term. The APR includes the interest rate and fees, and is therefore a more complete measure of a loan's cost than the interest rate alone. Lenders will assess your credit risk and ability to repay, taking into account your current income, employment history, and credit score, before they decide what terms to offer you.
If you’re looking to transfer the balance of a credit card to one with a lower interest rate, be sure you understand what the transfer fee will be – and if the rate will jump when the introductory period ends.
Review the fees
Additional fees and charges may also be associated with loans and credit cards and can increase the amount you will ultimately pay. Common examples include:
Origination charge: This is the amount charged for processing the loan application, underwriting services, and payments from the lender.
Prepayment penalty: If your loan has a prepayment penalty, you will be charged a fee if you pay off a loan before it is due.
Annual fees: Some credit cards charge annual fees for the convenience of using the card. The fee amount can vary, and is usually associated with rewards credit cards and secured credit cards.
Transfer fees: If you’re looking to transfer the balance of a credit card to one with a lower interest rate, be sure you understand what the transfer fee will be – and if the rate will jump when the introductory period ends.
If your loan has a prepayment penalty, you will be charged a fee if you pay off a loan before it is due.
Evaluate your options
Fixed rate: With a fixed rate loan, your interest rate and monthly principal and interest (P&I) payments remain the same for the life of your loan. The predictable monthly P&I payments allow you to budget more easily. With fixed rates, the amount of interest you pay on a loan remains the same for the life of the loan, which can be a good option if you want a stable, regular monthly payment.
Variable or adjustable interest rates: Variable or adjustable rate loans typically start with a lower initial interest rate than a fixed rate loan, but then may fluctuate over time. An interest rate cap typically limits the maximum amount your P&I payment may increase at each interest rate adjustment and over the life of the loan.
Term: It is a good idea to consider the total amount of interest and fees that would be paid over the life of the loan, along with what your budget can realistically manage in terms of monthly payments. For example, a consolidation loan with a longer repayment period may lower your monthly payment, but increase the total amount you repay. However, you can always pay off the loan faster by making more than the minimum monthly payment.
By understanding the terms, fees, and options, this information can help you to better understand the total cost of debt, plus help you to choose between different financing choices.
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