Your Retirement Center
The Cost of a Loan
Two things determine what borrowing will cost you: the APR and the length of the loan.
Loan AdvertisementThe cheapest loan isn't the one with the lowest payments, or even the one with the lowest interest rate. Instead you have to look at the total cost of borrowing, which depends on the interest rate plus fees, and the term, or length of time it takes you to repay.

WHAT YOU LEARN FROM ADS Lenders are required to tell you what a loan will actually cost per year, expressed as an annual percentage rate (APR).

Some lenders charge lower interest but add high fees. Others do the reverse. The APR allows you to compare them on equal terms. It combines the fees with a year of interest charges to give you the true annual interest rate.

For example, suppose you take a $10,000 loan at 10% interest. You also pay an origination fee of $350, leaving you with $9,650 as the actual borrowed amount. Since you are getting a smaller loan, but repaying the full $10,000 with interest, the cost is more than 10%. The APR, or actual percentage rate, is closer to 10.35%.

In contrast, the periodic interest rate, also called the nominal rate, is the interest rate the lender charges on the amount you borrow. If the lender also charges fees, the periodic rate will be lower than the APR.


WHAT YOU LEARN WHEN APPLYING Every lender is required to provide a total cost disclosure, called a Truth-in-Lending disclosure, before a loan is made. This is the only place where you can see in dollars and cents what the loan will actually cost you.
 
Truth in Lending Disclosure Statement

The disclosure will provide the:
Finance charge, or the dollar cost of borrowing. For most loans, it includes all the interest, fees, service charges, points, credit-related insurance premiums, and any other charges.

Amount financed, or the amount you are borrowing.

Total of payments, or what you must repay the lender. Add your cost, or finance charge, to the amount you borrow, to find the total amount.

Annual percentage rate, or the cost of borrowing as a yearly rate.



THE COST OF TAKING LONGER TO REPAY

The term of your loan is crucial when determining cost. Shorter terms mean squeezing larger amounts into fewer payments. But they also mean paying interest for fewer years, which saves you money.

Consider, for example, the interest for three different terms on a $15,000 loan at 6% APR.


3 year 4 year 5 year
Number of monthly payments 36 48 60
Amount of each payment $456.33 $352.28 $290
Total repaid $16,427.88 $16,909.44 $17,480
Total interest paid $1,427.88 $1,909.44 $2,400



 
Loan FeesTHE FEES ARE THE THING Be careful to ask about all fees — they add up very quickly and can substantially increase the cost of your loan. Each type of loan has a different set of fees. Here are some you might encounter.

Application fee covers processing expenses.

Attorney fees pay for the lender's attorney. Fees for your own attorney are extra.

Credit search fee covers researching your credit history.

 

 

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