The Total Cost of Borrowing
6 Min Read | Published: August 30, 2024
This article contains general information and is not intended to provide information that is specific to American Express products and services. Similar products and services offered by different companies will have different features and you should always read about product details before acquiring any financial product.
See how much it really costs to borrow funds. Learn how APR and the length of the loan or line of credit can significantly impact the cost of borrowing.
At-A-Glance
- The total cost of borrowing refers to the exact amount you’ll pay to take out a loan or line of credit.
- Factors like your loan term, the interest rate, and additional fees can all impact the true cost of financing.
- Before you sign on the dotted line and move forward with a loan, it’s important to make sure you know how much it’ll cost you.
When you take out a loan or line of credit, it’s important to understand the true cost of borrowing. This can help you to budget more accurately for the loan and assess whether it’s a good fit for your needs.
In general, the total cost of a loan will be based on a number of different factors, such as the amount borrowed, interest rate, and loan term. Let’s dive deeper into how you can determine the overall cost of borrowing and make smart decisions about credit.
How Much Does It Cost to Borrow?
Before you go ahead and commit to a loan, it’s a good idea to consider these factors as they can all impact your true cost of borrowing:
- Amount Borrowed
The amount borrowed or “principal” will be the first factor that will affect how much you pay for a loan.1 While it may be tempting to borrow as much as you can get approved for, it’s in your best interest to only borrow what you need. If you end up overborrowing, you could end up spending more, which could make it more challenging to pay the loan back. - Interest Rate
Interest rate refers to the price you’ll pay to borrow money. A lower rate could help you to save a significant amount of money over the life of your loan. Note that a rate may be fixed and stay the same, or it can be variable or adjustable, which means it can fluctuate based on factors such as market conditions.2
Did you know?
Most lenders will look at your credit score when you apply for a loan. Strong credit may help you to qualify for a lower interest rate. Depending on the loan, this could help you to save a considerable amount in interest over the life of your loan.
- Annual Percentage Rate (APR)
Your Annual Percentage Rate (or APR) includes the interest rate as well as fees your lender will charge. Compared to the interest rate alone, an APR can give you a better picture of the annual price of a loan.3 - Whether Interest Is Simple or Compound
Interest may be simple or compound. With simple interest, interest is calculated annually as a percentage of the principal balance. Compound interest, on the other hand, applies interest to the principal balance as well as any accrued interest.4 - Frequency of Compounding Interest
When interest compounds, this means that interest accumulates on any accrued interest and the principal. Your interest charges may be higher if your interest compounds more frequently.5 - Amortization Schedule
A loan amortization schedule is a table that outlines all of the scheduled payments on a loan. It explains exactly how much of each of your payments will go toward principal or interest throughout the loan term.6 - Duration of Loan
Loans can be short-term or longer-term. While a longer term can lead to lower monthly payments, it may also cost you more in interest in the long run.7
Additional Fees and Charges
Some lenders charge fees in addition to interest, such as:8
- Origination Fees
An origination fee is intended to pay for the underwriting of a loan. Origination fees are typically between 1% and 6% of your total loan amount. - Application Fees
While application fees aren’t as common as origination fees, they do exist. If your lender does charge an application fee, you’ll likely pay it when you apply for a loan. - Prepayment Penalties
If you decide to pay off your loan early, you may face a prepayment penalty. This may be a flat fee or a percentage of your total loan balance. - Late Fees
Many lenders will penalize you with a late fee if you make your payment after the due date. This amount will vary, depending on the lender.
Did you know?
If you’re looking for financing, American Express® Personal Loans are available for eligible Card Members. You can apply online and get a decision in seconds.
Before applying for any loan, you’ll want to make sure you’ll be able to afford the repayments. You’ll also want to shop around to make sure you’re getting the best loan terms possible. Don’t forget that you may be able to take steps to reduce the cost of your loan by reducing the amount borrowed or shortening the duration of your loan. Be sure to speak to your lender for advice on reducing the cost of borrowing to see what your options are.
Frequently Asked Questions
Your unique situation will determine how much you can afford to borrow. A loan calculator can give you a good idea of what is realistic. You can also work with a financial advisor who may be able to provide you with personalized guidance.
Interest rates can vary depending on a number of factors. Some factors like your credit score, income, and employment history may be within your control. Other factors, such as economic conditions, are outside of your control.
To save money on your loan, you may want to consider working to build strong first credit. This may help you to qualify for a better interest rate. You can also shop around. You may also want to consider reducing the amount borrowed or reducing the duration of your loan.
The Takeaway
It’s important to understand the true cost of borrowing as this can help you to see whether the loan is a good fit for your finances. It can help you to budget for the loan. Factors like the amount borrowed, your interest rate, loan term, and repayment schedule, can all impact the cost of borrowing money.
1 “How to Calculate Loan Payments and Costs,” Bankrate
2 “Understanding the Different Kinds of Loans Available,” Consumer Financial Protection Bureau
3 “What Is an APR?,” Experian
4,5 “Simple vs. Compound Interest: Definition and Formulas,” Investopedia
6 “What Is an Amortization Schedule? How to Calculate with Formula,” Investopedia
7 “Loans Terms: Specific Terms Defined & How to Negotiate Them,” Investopedia
8 “5 Personal Loan Fees to Watch Out For,” Experian
Anna Baluch is a personal finance writer from Cleveland, OH. She enjoys helping people from all walks of life make smart financial decisions. Her work can be seen on Credit Karma, Forbes, LendingTree, Insurify, and many other publications. Connect with Anna on LinkedIn.
All Credit Intel content is written by freelance authors and commissioned and paid for by American Express.
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The material made available for you on this website, Credit Intel, is for informational purposes only and intended for U.S. residents and is not intended to provide legal, tax or financial advice. If you have questions, please consult your own professional legal, tax and financial advisors.
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