What Borrowing Really Costs

The story: Two loan offers

At a bank, Jade compares two loan offers with the same rate: a short loan with a higher payment and a long loan with a lower payment.

1. Narrator: Jade plans to borrow $3,000 for a trade-school course. The lender offers two choices at the same 12% APR.
2. Banker: Option A: about $141 a month for 2 years. Option B: only about $67 a month for 5 years.
3. Jade: Option B’s payment is so much lower. That one’s cheaper, right?
4. Narrator: Look at the total. Option A repays about $3,390. Option B repays about $4,004, because interest runs 3 more years.
5. Narrator: Same APR, longer term: a lower payment, but more total interest.
6. Jade: So I’ll compare APRs first, then pick the shortest term with a payment I can really make.
7. Narrator: Look at the total, not just the payment.

What you’ll learn

1. The parts of a loan

   A loan has three parts. Principal is the amount borrowed. Interest is the price of borrowing. The term is how long there is to repay. An installment loan is repaid in equal monthly payments over the term.

2. APR compares loans

   APR, the annual percentage rate, includes the interest rate plus some required fees. One example is a fee to set up the loan. That makes it the best single number for comparing loans. Late fees aren’t in it.

3. Longer term, more interest

   Stretching a loan over more months lowers the payment. But interest runs longer, so the total cost of credit goes up.

   Example: $3,000 at 12% APR. 2 years: about $141 a month, $389 interest. 5 years: about $67 a month, $1,004 interest.

4. Is it worth it?

   Before borrowing, many people ask: will this raise future income or value, like training for a better job? Or will the thing be gone before the loan is paid off? The answer changes how much cost makes sense.

Key words

APR

the yearly cost of a loan, including some required fees

Also called: annual percentage rate

term

how long you have to repay a loan

total cost of credit

everything you pay to borrow, beyond the amount borrowed

installment loan

a loan repaid in equal payments over a set time

Common questions

Why do some loans have fees on top of interest?

Some lenders charge a fee to set up the loan, called an origination fee. APR folds required fees like that into one yearly rate, so loans are easier to compare.

Remember this

Look at the total, not just the payment.

Try it: Run the sample loan

1. Open the loan payment calculator.
2. Enter the sample loan: $3,000 at an example 12% APR.
3. Try a 2-year and a 5-year term, and write down the payment and total interest for each.

Run the sample loan through the loan payment calculator embed.