Comparing loan costs helps students understand the real price of borrowing money before signing an agreement. This cheat sheet explains how principal, interest, fees, APR, monthly payments, and loan length affect what a borrower pays. It is especially useful for comparing auto loans, personal loans, student loans, and credit offers.
Students need these skills to make informed financial decisions and avoid costly borrowing mistakes.
The most important idea is that the lowest monthly payment is not always the cheapest loan. APR gives a broader yearly cost because it includes interest and certain fees, while the total repayment amount shows the full cost over time. A longer loan term usually lowers the monthly payment but increases total interest paid.
To compare loans fairly, use the same loan amount, term, payment schedule, and fee assumptions whenever possible.
Key Facts
- Principal is the amount borrowed, and total repayment equals the sum of all payments made over the life of the loan.
- Simple interest is calculated with I = P x r x t, where P is principal, r is annual interest rate as a decimal, and t is time in years.
- Finance charge equals total repayment minus the amount borrowed, so Finance charge = Total of payments - Principal.
- APR is the annual percentage rate that reflects the yearly cost of credit, including interest and certain required fees.
- A lower monthly payment can cost more overall if the loan term is longer and interest continues for more months.
- Monthly loan payment comparisons should include interest rate, APR, fees, loan term, down payment, and total amount financed.
- For a fixed-rate installment loan, the payment stays the same each month, but early payments include more interest and later payments include more principal.
- To compare two loans, calculate Total cost = Down payment + All monthly payments + Fees not included in the loan.
Vocabulary
- Principal
- The original amount of money borrowed before interest and fees are added.
- Interest
- The cost paid to borrow money, usually calculated as a percentage of the unpaid loan balance.
- APR
- The annual percentage rate that estimates the yearly cost of borrowing, including interest and certain required fees.
- Finance Charge
- The total dollar cost of borrowing, including interest and applicable fees paid over the loan period.
- Loan Term
- The length of time a borrower has to repay a loan, such as 36 months or 60 months.
- Amortization
- The process of paying off a loan through scheduled payments that gradually reduce the balance.
Common Mistakes to Avoid
- Choosing the lowest monthly payment only, because a longer term may create a much higher total cost even when each payment feels affordable.
- Comparing interest rate instead of APR, because APR includes certain fees and usually gives a more complete cost comparison.
- Ignoring fees, because origination fees, application fees, and closing costs can make one loan more expensive than another.
- Forgetting to convert percentages to decimals, because using 8 instead of 0.08 in a formula makes the interest calculation 100 times too large.
- Comparing loans with different terms without checking total repayment, because a 72-month loan and a 36-month loan do not have the same time cost.
Practice Questions
- 1 A borrower takes a $6,000 loan at 7% simple annual interest for 3 years. What is the interest charge using I = P x r x t?
- 2 Loan A has 48 monthly payments of 200 fee. Loan B has 60 monthly payments of $260 and no fee. Which loan has the lower total cost?
- 3 A student borrows 15,480 over the life of the loan. What is the finance charge?
- 4 Why might a loan with a lower monthly payment be more expensive than a loan with a higher monthly payment?