If you’re shopping for a loan, line of credit, or credit card, it’s important to consider all the costs involved — not just the monthly payment. Make sure you know your total cost of borrowing by looking at these four things:
1. Loan amount
The amount you borrow can influence the interest rate, terms available and possible fees you pay over the life of the loan. So, determine how much you actually need to borrow. The higher the loan amount may require a longer term to keep your monthly payments manageable.
2. Interest rate / APR
When comparing rates, you will want to focus on the annual percentage rate rather than simply looking at the interest rate. The annual percentage rate (APR) is the amount of annual interest plus fees you’ll pay averaged over the full term of the loan. Focusing on the APR allows you to better compare the cost of borrowing from different lenders, since they may all have different fee structures. Look for an account with a low APR — the lower the APR, the lower your monthly payment will be.
Fixed or a variable rate?
Loans typically have a fixed rate and fixed term, while a line of credit or credit card has a variable rate and a revolving term. Know the pluses and minuses of each:
- With a fixed-rate loan, your interest rate and monthly payment never change. And because the payment includes both principal and interest, your loan will be paid off at the end of the term. Having a predictable monthly payment can make it easier to stay on budget and manage your finances.
- With a variable rate loan or line of credit, your interest rate and monthly payment can change over time. The initial interest rate may start lower than a fixed-rate loan, but can increase over time. So, keep in mind how long it will take you to pay off your debt as changes in the rate could impact your monthly payment.
3. Loan Term
When you’re choosing the term — or length of the repayment period — consider what that term will do on the total amount of interest you’ll pay on your loan over time. A loan with a longer repayment period may have a lower monthly payment, but it can also increase the total amount you pay over the life of the loan. Even if you choose a longer term, remember you can still pay less interest over time by making additional payments toward principal.
Payment terms affect your monthly costs
For example, with a $15,000 loan at 7.75%, and a payment term of 3 years, you would pay $468.32 per month. But if you changed the term to 5 years, you’d lower your monthly payment to $302.35 per month.
Keep an eye on how the total money you will pay back over the loan term (your total cost of borrowing). Most loans allow you to pay more than your scheduled monthly payment. The more money you are able to put toward the principal, the faster you'll pay off your loan - and the less you will pay in interest.
This chart is for illustration purposes only.
4. Loan Fees
Check for additional fees and charges that can increase the amount you pay — the more fees, the higher the cost of borrowing. Common fees include:
- Origination fees - the amount charged for processing the loan application and underwriting services
- Prepayment penalty - the fee charged if you pay off your loan before the end of the term
- Annual fees - the amount you’ll pay each year for having the account
- Transfer fees - the fee for transferring your balance from one credit account to another