How Can You Reduce Total Loan Cost?

Many people may not realize that when you take out a loan, it's very important to pay attention not only to the interest rate, but also to how fast the loan will be repaid.

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These two factors are critical in determining how much you will have paid when the loan is fully repaid. Furthermore, there are ways to reduce your upfront costs–let’s look at ways you can reduce the total cost of a loan and how you can improve your credit profile by using credit repair companies in Austin, Texas.

How Interest Rates Affect the Total Loan Cost

Let’s say you’ve borrowed $10,000 from the bank at a 4% annual interest rate. If your loan has a repayment schedule of one year, at the end of the year, you will have paid the bank $10,400. ($400 is 4% of $10,000). Divided into twelve monthly payments, this means each month you will pay $867–this is how interest works at its most basic level. 

The above does not include any closing costs or fees associated with the loan that the bank may add to the total balance. 

Combining Interest Rates and the Repayment Period

We will now use the $10,000 amount above, but we will change the repayment period from one year to five years. Again, we will use the interest rate of 4%. 

4% of $10,000 is $400—multiplied by five years, this is $2,000. Therefore, your total loan amount will be $12,000. Divided by sixty (twelve monthly payments multiplied by five years), each month your monthly payment will be $200. Though taking longer to repay the loan means a lower monthly payment; you can see how when the loan is finished being repaid, you will have paid the bank a far larger amount of money.

Ways to Reduce the Total Amount Paid

First, we need to explain that when you start making payments on your loan, for the first year—or perhaps five, in the case of a thirty-year mortgage—large portions of the money you are paying go directly to the interest owed. The remainder is applied to the principal (the actual amount borrowed). In this way, the bank gets its interest money upfront, so if you pay the loan off early, it still makes money. This is explained through a process known as amortization.

For this example, we’ll be using a five-year loan of $10,000 at a 4% interest rate. Here is how each payment will be applied for the first year:

<img src="https://ibb.co/GCpSN5Y">

Based on the above, you can see how each month you are paying a little less interest, and a little more towards the principal. By the last year of the loan, nearly all the payment will be applied to the principal and almost nothing to the interest. 

We can reduce the total loan amount by making additional payments to the loan. Instead of paying $184.17 as noted above, say you pay $300–the extra money will be applied directly to the principal balance and will shorten the life of the loan, thereby saving money in the long run. Using the exact example above, you will pay off the loan two years early and save yourself over $400 in interest, so, imagine how much you would save on a thirty-year mortgage for $300,000.

What if My Interest Rate Is Too High?

Loans are closely connected with credit scores—a very important aspect of financial life. You may have wondered what credit score you need for an apartment in Austin, Texas or asked yourself if a divorce is negatively affecting your credit. If you’re being offered high interest rates, it may be time to obtain a copy of your credit report and make sure each item listed is accurate so you can know you have the best credit score possible.

Doing this yourself can be very time-consuming and may involve hours on hold with banks and creditors. Entrusting this process to a qualified credit repair company like The Phenix Group can help you get these inaccuracies removed and get your credit back on track so you can get the loans you need to live your best life.

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