Understand the total cost of borrowing

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 loan amount is the initial sum of money you borrow. It’s also known as the principal. This amount directly influences the interest rate, terms, and potential fees you may pay. It’s important to decide precisely how much you need to borrow and to avoid borrowing too much. A higher loan amount might require a longer term to keep monthly payments manageable, which increases the amount you pay in interest and can increase the total cost of borrowing.

Tip

Do your best to borrow only what you are comfortable paying back over time. Be mindful that overextending yourself with higher loan amounts can create more stress.

2. Interest rate/annual percentage rate (APR)

Lenders charge interest when you borrow. The rate you pay is based on factors such as the amount you borrow, your term, and your credit history. It’s typically expressed as a percentage. APR includes both the interest rate and any additional fees, averaged over the loan term – and it’s also expressed as a percentage. Comparing APRs across different lenders gives you a more comprehensive understanding of the total cost of your loan.

Interest rates may be fixed or variable. Fixed rates don’t change over the life of a loan. They offer stability, with consistent monthly payments that may make budgeting easier. Variable interest rates may increase or decrease over time depending on economic conditions. Changing rates can affect your monthly payments and the total cost of borrowing money.

Tip

Your credit history influences the APR you qualify for. A strong credit score can secure a lower APR, reducing your monthly payments and the total cost of a loan.

3. Loan term

The loan term is the duration over which you repay the money you borrow. It affects both your monthly payment and the total interest paid. A longer term can lower monthly payments but can increase the total cost of borrowing as you pay interest over a long period of time. Consider the following hypothetical comparison:

• A $15,000 loan at a 7.75% APR with a 10-year term would have monthly payments or $180.02. The total cost of the loan, including interest and fees would be $21,602.40.
• The same loan with a five-year term would have $302.35 monthly payments, and the total cost of borrowing would be $18,141.00.
• Finally, the same loan with a three-year term would have $468.32 monthly payments and the total cost of borrowing would be $16,859.52.

Tip

Pay more than the minimum monthly payment when possible. Even small additional payments can reduce the loan term and total interest costs.

4. Loan fees

Fees are typical of most loans, but can significantly affect the cost of borrowing money. Some common fees include:

• Origination fees for processing the loan application.
• Prepayment penalties for paying off the loan early.
• Annual fees for maintaining the account.
• Transfer fees for moving balances between accounts.

Tip

Before transferring a balance to a lower interest account, check the balance transfer fee and whether the APR will increase after the introductory period.