# What a loan actually costs The interest rate is the headline, not the cost. Origination fees, insurance, prepayment penalties and term length decide what you really pay. Two loans with the same advertised rate can cost very different amounts. The rate is one of at least five numbers that decide what you repay, and it is the one most designed to be compared. This guide covers the others, and how to put them on one footing so the comparison is honest. ## The five numbers that set the cost The interest rate, and whether it is fixed or variable. On a fixed rate the payment is known. On a variable rate it is not, and the payment can move with the market. The term, because interest accrues for as long as the balance exists. Doubling the term roughly doubles the interest even at a lower payment. The origination fee, which is often deducted from the amount you receive, so a fee on a loan leaves you with less than you borrowed and the same debt to repay. Insurance and add-ons, frequently presented as optional and priced per dollar borrowed rather than as a rate. Prepayment terms, which decide whether you can escape the schedule cheaply by overpaying. - Ask for the amount you receive and the amount you repay, both in writing. - Ask whether the origination fee is deducted from the principal. - Ask whether extra payments reduce principal immediately. - Ask what the rate becomes when a promotional period ends. ## Put everything on the same footing The only fair comparison between two loans is the total amount repaid for the same borrowed amount over the same period. Work that out and the marketing collapses: a lower rate with a large fee frequently loses to a slightly higher rate with no fee. A loan payment calculator returns the monthly payment, total interest and total repaid, and shows the balance and cumulative interest at each year end. That last view is where a long term reveals itself, because the early years are mostly interest. ## The affordability question comes first Before comparing loans, establish what payment you can carry. An affordability calculator applies a debt-to-income limit to gross monthly income, subtracts existing debt payments, and converts the remainder into a loan amount. Lenders apply their own limits and weigh credit history, employment and collateral, so treat the result as a ceiling to test quotes against, not an approval. A loan you can only afford in a good month is not affordable. Size the payment against a bad month, then compare offers within that limit. ## The comparison that ends the argument For each offer, compute the total amount repayable for the same borrowed amount over the same number of months. That single figure includes the rate, the term and every fee that is financed, and it is the number the marketing avoids. If one offer cannot produce it, multiply the payment by the number of payments and add any fee paid up front. Where the amounts borrowed differ because a fee is deducted, compare total repayable per dollar actually received. That is the honest unit price of the borrowing, and it is the number to rank offers by. ## A checklist to run on every offer Fill in the same eight fields for each offer, then compare the sixth: amount borrowed; amount actually received after fees; annual rate and whether it is fixed or variable; term in months; monthly payment; total amount repayable; whether extra payments reduce principal immediately; and any prepayment penalty. The sixth field decides the comparison, because it includes every fee and every month of interest. Where an offer cannot answer one of the eight, treat it as incomplete rather than assume the missing item is free. ## Why the monthly payment is the wrong headline A monthly payment can be lowered by stretching the term, which costs money, or by adding a balloon payment at the end, which moves the cost rather than removing it. A balloon structure makes the payment look small for the whole term and then requires a lump sum or a refinance at whatever rate is available at the time. If a payment looks materially lower than other offers for the same amount, ask what happens at the end of the term before you ask anything else. ## Insurance, add-ons and what is genuinely optional Payment protection, credit insurance and extended warranties are commonly offered alongside a loan and priced per dollar borrowed, which makes them look small and cost a great deal relative to the cover. They are often optional, and in several places they must be presented as optional. Ask directly whether declining changes the rate or the approval, and get the answer in writing. If you need the cover, buy it separately where that is possible, so you can see its actual price rather than a per-dollar-of-balance figure buried in a payment schedule. ## Related pages - Personal loan costs - Loan payment calculator - Affordability calculator Source: https://costreference.com/guides/what-a-loan-actually-costs/