What you should know about loans
Every day we see commercials with a price shown as a monthly payment, but how often do we really think about the total cost of those items sold. If you haven't calculated the cost of buying something with a loan you might be suprised that in some cases it might be twice as expensive as buying it without loan. What influences total payments?
The most important factor of a loan is an interest. Interest is shown as a percentage and is calculated annually. The percentage shows at what cost the lender is willing to give out loan.
The next important thing about loans is repayment period. It's the period in which the loan must be paid back.
In addition to interest and repayment period one should see if there is any fees, fines, overdue charge or other conditions that may influence the loan.
What makes a loan expensive?
1) big interest
2) long repayment period
3) additional loan fees and fines
Long repayment period may sound good because it lowers the monthly payment but overally it makes a loan expensive and as a result the total payments become much bigger. In case you take a loan always calculate how repayment period influences the total amount of monay paid back. Most of us are afraid of big interest but we also should be afraid of long repayment period.
How repayment period influences total payments?
Here is an example of how loan period influences payment:
Loan amount: $10 000
Annual interest rate: 5%
12 months = 856.07 (monthly payment) x 12 (months) = 10272.84
24 months = 438.71 (monthly payment) x 24 (months) = 10529.04
36 months = 299.71 (monthly payment) x 36 (months) = 10789.56
48 months = 230.29 (monthly payment) x 48 (months) = 11054.06
60 months = 188.71 (monthly payment) x 60 (months) = 11322.74
And that is only interest rate of 5%. The difference between 12 and 60 months is 1049.90 dollars. It means you have to pay extra 1049.90 dollars if you want to expand repayment period from 12 to 60 months. With bigger interest it would be even more drastic.
This graph is an example of how loan period (from 1 year to 12 years) changes total and monthly payments. It's already told before that longer period is actually more expensive as the total payment is bigger. And as you can see from the graph that there is a point from where the longer period actually doesn't make your monthly payments that much smaller anymore. So, the monthly payment is pretty much the same but the payment period is longer. That means you just pay extra for basically nothing.
Why and when you want to loan money?
In case you really need something but you have no free money to buy it
In case you invest the borrowed money and it brings you an income
In case you can make more money out of your free money than you pay back to the bank
Try the calculator yourself!