Total Loan Cost and How You Can Reduce It

Updated on October 2, 2022 Reviewed by Josh Mora, CFP

When you borrow money did you realize there are more costs than just interest? Many people don’t even know how to do the math to determine the total loan’s cost. They focus on the monthly payment, see what they can afford and accept the loan.

Borrowing money is an emotional decision and should not be treated lightly. The one lending you money is there to satisfy their shareholders and sales managers- you are just a number. Think about it, you are asking for something you cannot afford and making yourself into a corporate servant. 

It is critical to also know that banks use a formula based on your gross income and credit score, they want you to take the maximum amount. You are just a number on a computer for them, no bankers or online lenders care about who you really are.They will present to you a loan amount that you “qualify” for that suits their profit motives and fits their commission goals.

If you have not done your due diligence about loans- You can expect to be presented with a loan program that doesn’t account for increased inflation, taxes, or the overall cost of living.

So how do you know your total loan’s cost, and can you reduce it? Find out below.

What is the Total Loan Amount?

The total loan amount is a combination of the amount you borrow plus the fees you pay. Sometimes you are forced to include the fees within your loan, or you can pay out of pocket for them. Each loan has a different total loan amount. For example, credit cards charge only interest – there aren’t any other fees associated with it unless you miss a payment and are charged a late fee.

Other loans, such as personal loans and mortgage loans charge fees, aka closing costs, also known as “points.”. You might pay an origination fee, processing fee, underwriting fee, and title fees as a few examples.

To figure the total loan amount on your loan, you’ll need the principal (amount you borrow), monthly interest, loan term (how long you have to repay the loan), and the total fees.

The good news is lenders are required by law to disclose all fees before you sign on the dotted line for a loan. It’s up to you to read the paperwork to make sure you understand it, though.

Loan Amount Example

Let’s look at a couple of loan amount examples. To figure out your total loan amount, use the following calculation:

Monthly payment x number of years x payment frequency per year + closing costs (if applicable)

First, let’s say you took out a personal loan with no fees.

You borrowed $10,000 at 6% for 4 years. There aren’t any closing costs. Your total loan cost is:

$234.85 x 4 (years) x 12 (payments per year) = $11,272.80

Now let’s look at a mortgage loan

You borrowed $100,000 at 4% for 30 years. The closing costs are $4,000. Your total loan cost is:

$496.51 x 30 (years) x 12 (payments per year) + $4,000 (closing costs) = $178,743.60

How You Can Reduce your Total Loan Costs

Looking at the numbers above, it’s obvious that it’s expensive to borrow money. Fortunately, there are ways to reduce your loan costs.

Before you can determine how to reduce your loan costs, you must narrow down your financial goals. Ask yourself what you are trying to achieve.

Are you:

  • Looking for lower monthly payments?
  • Trying to pay your loan off as fast as possible?
  • Looking for an adjustable rate loan that can withstand income changes (better or worse)?

Next, consider your future goals. Ask yourself:

  • Am I borrowing the money for an appreciating asset (house) or depreciating asset (car)?
  • Will I hang onto the asset for the long term or is this a short-term deal?

Knowing the answers to these questions will help you determine how to best lower your loan costs. You have to main options:

  • Secure a lower interest rate
  • Take a shorter term loan
  • For a mortgage, increase your down payment if possible

If you qualify for a lower interest rate, you lower the cost of borrowing the money. You’ll need great credit, stable income, and a low debt-to-income ratio to qualify for a low interest rate on most loans. 

If you take the shorter term, the loan costs less automatically because you pay less interest over the life of the loan. The longer you borrow money, the more it costs and the quicker you pay it back, the less you pay. 

Reducing by Loan Type

The type of loan you need determines how you reduce your total loan cost.

Home Loans

You can reduce the total cost of your mortgage by qualifying for the lowest interest rate, taking a shorter loan term, and shopping around for the lowest closing costs.  You can also decide on how much to use for a down payment, typically 3%-20% of the home value.

If you can do all three, you’ll save the most money on your home loan. But even focusing on one area can help keep your costs low. For example, if you can afford a 15-year term payment instead of a 30-year payment, you’ll save almost half of the interest you’d pay on a 30-year loan.

If you need the 30-year term for the lower payment, make sure your qualifying factors are as good as possible to get the lowest interest rate.

Home Equity Lines of Credit

If you own a home with equity in it and want to borrow against it, you can lower your loan cost by finding a lender that doesn’t charge closing costs. Usually if you borrow a HELOC from the lender that has your first mortgage, you can cut your closing costs down drastically.

You can also look for a HELOC with the lowest variable interest rate or a loan that allows you to lock in a fixed interest rate for a portion of your loan.

Student Loans

Student loans are deferred, which means you don’t have to make payments until 6 months after you graduate or stop going to school. However, the interest still accrues. The best way to keep your costs down on student loans is to keep up with your payments and even pay interest during the deferral period to reduce compounding interest.

Credit Card Loans

The best way to keep your credit card costs down is to pay your balance in full each month. Don’t treat your credit card like an extension of your income. Instead, use it to protect large purchases or to make purchases you need to make with a credit card like airline tickets and hotel stays, but pay the balance in full before the due date.

If you can’t pay your balance in full, try to qualify for a 0% APR balance transfer credit card and pay the balance off before the 0% APR expires. This way you pay no interest on the balance but have a little more time to pay it off. It’s important to note that if you do not payoff a balance transfer credit card within the term they will retroactively charge the interest that was owed.

Final Thoughts

Knowing your loan’s full cost can help you make sure it’s right for you. Don’t get caught in a loan that costs you so much that it’s an opportunity cost for other financial goals. Know the costs, the total interest and how much the loan will cost you at the end of the term to decide if it’s right for you.

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