Borrowing money? Curious what it will cost you? Read on to learn the costs and fees you may be charged when taking out a loan.
Looking For A Loan, It May Cost You
Obviously, when you borrow money from a bank or other lending institution it will cost you more than the principle. Unless your lender is a family member or friend it may cost you in more ways than one including but not limited to the interest rate. If you are not aware of the fees and costs of your loan it could end up costing more than it’s worth.
- Interest Rate – The interest rate is the amount, usually a percentage, of the outstanding principle a borrower has to pay. Rates are set using a number of factors including your credit score, the amount of the loan and whether it is secured or not. Borrowers with higher credit scores and established credit history command the best rates. Likewise, secured loans typically command better rates than unsecured loans. When it comes to loans there are two rates to be aware of; the nominal rate and the effective rate. The nominal rate is the advertised interest rate for you loan. The effective rate is the actual amount you pay based on compounding and amortization.
- Contract Length – Contract length plays a very important role in determining the cost of your loan. The longer the term, the more payments, the more interest the higher the cost. Think about it like this; a 30 year loan for a house costing $135,000 may end up costing the borrower $250,000 by the time the loan is paid off because the nominal rate is added to the principle each month, and paid before the principle. As a borrower it is in your best interest to pay back loans as quickly as possible, as a lender it is in their best interest to provide the longest terms possible in order to earn maximize interest.
- Origination Fee – Many lenders charge an origination fee. This is a fee to cover the cost of processing a loan and is intended to compensate the lender for putting the loan in place. Fees are typically a percentage of the loan, in the range of 0.5% to 1%, and can be negotiated as part of the loan application process. Generally speaking, a lender will be willing to waive or lower an origination fee for large loans or for repeat business in order to secure future nterest payments.
- Points/Mortgage Points – A point is another word for 1%. Many loans, especially mortgage type loans, require the borrower to pay up front points. These can be in the form of origination fees as described above, but can also be a prepayment of interest charges. Prepayment of interest is a viable method of lowering the overall interest rate and by extension the overall cost of the loan but require the borrower to pay before the funds are released. Whether or not to pay points is based on factors such as how much cost savings can be had, and how long you intend to live/own the property in question.
- Prepayment Penalty Fee – Some loans, including some debt consolidations, auto loans and sub-prime loans, come with a penalty for early payment. This fee can be 2% of the principle or up to 6 months of interest payments depending on loan type and your country of residence. These fees are intended to protect the lender who has made an investment in you; if you pay off a 5 year loan in only 2 years the lender is out 3 years of interest payments and profits. These fees can mean the difference between paying off one loan over another if they negate the positive impact of early repayment.
Shopping Around For A Loan
It goes without saying that shopping around for the best deal can save you lots of money. When it comes to your loan it could mean thousands, or tens of thousands, of dollars over the course of the loans duration. Understanding the cost, your interest rates and possible penalties is the key to choosing the best loan for you. Luckily, there are a wide variety of calculators available on the internet that you can use to forecast what a loan, early payment or refinancing will cost versus other loans, or doing nothing at all.