In this article:
Loans can help you finance important purchases such as a vehicle, education or home, along with just about anything else. But if you're thinking about taking out a loan, whatever the reason, it's a good idea to understand the total cost of the loan and how you might be able to reduce what you have to pay back.
4 Factors That Determine Your Loan Costs
Factors that can impact your loan costs include:
- Interest rate: When you borrow money, your lender will typically charge interest on the balance you owe. The interest rate can be expressed on its own or as an annual percentage rate (APR), which includes fees and interest.
- Credit score: When you apply for a loan, lenders typically look at your credit score to evaluate your ability to pay the loan back and determine an interest rate. Higher scores indicate less risk to the lender.
- Income and debt: Especially with large loans such as a mortgage, the lender will consider your income and how much of your income goes to debt payments each month.
- Loan terms: Depending on the lender and type of loan, loan terms can include the length of the loan, fees and more.
These factors all play a part in the total cost of your loan. But that doesn't mean you have no control when it comes to how much you ultimately pay to borrow money. To reduce your loan costs, consider making the following moves.
1. Increase Your Credit Score
Keeping your credit in good shape may give you more loan options and help you get a better interest rate on your loan.
Before applying for a loan, it's a good idea to check your credit score to see where you stand. If it's not where you want it to be, consider taking steps to improve your credit health before you apply. These include:
- Pay down credit card balances.
- Pay off any collection accounts and bring past-due accounts current.
- Make all debt payments on time going forward.
- Check your credit report for any inaccuracies and dispute them if necessary.
2. Compare Lender Offers
Shopping around and comparing offers for your next loan may help you save money. And depending on the type of loan you need, you might have a range of loan options and lenders to choose from.
For example, if you're trying to buy a house and need a home loan, you can compare different mortgage options, such as government-backed loans and conventional loans. You can also shop for loans from different lenders, including local banks, online banks and mortgage brokers.
The same goes for personal loans, auto loans and more. When comparing loan options and lenders, be sure to compare loan APRs, repayment terms and any other fees that may apply, such as origination fees or prepayment penalties.
3. Set Up Autopay
Another way you may be able to cut back on the cost of your loan is by setting up automatic bill payments, or autopay. Depending on the lender, your interest might be slightly reduced if you agree to automate your loan payments. And even if you don't get a discount, autopay can help you avoid penalties and potential damage to your credit score by ensuring that you never miss a payment.
4. Make Extra Payments
Paying more than the minimum you owe each month can not only help you pay down your debt quicker but can save you money in interest over the life of the loan.
For example, if your home loan payment is $1,200 a month and you add an extra $100 to each payment, you'll end up making an extra monthly mortgage payment every year. While this may not seem like much, the savings can add up to thousands of dollars over the life of the loan.
You can also opt to send in more than one loan payment a month if your lender allows it. For example, if your $500 car payment is due on the first of the month, consider following up that payment with another, smaller payment on the 15th. This will help you pay the loan down faster and save on interest.
Before deciding to pay off your loan early, it's important to check your loan terms to make sure you won't get hit with any fees or prepayment penalties for doing so.
5. Refinance Your Loan
If interest rates start to drop or your personal financial or credit situation improves during the course of your loan repayment, it might be worth looking into refinancing your existing loan. You may be able to get a better interest rate, lower monthly payments or even a shorter loan term, which can help reduce the cost of your loan over time.
The Bottom Line
Loans can help you cover the cost of a large purchase, but the cost of borrowing can get expensive. It's important to understand all of the terms of your loan before signing on the bottom line so you know what you'll ultimately pay. If you can take steps to reduce your total cost, even better.
Staying on top of your credit is an important way to understand how much borrowing money may cost you and whether you may be able to take action, such as refinancing, to reduce those costs. Free credit monitoring from Experian allows you to monitor your credit report and score, and take steps to help boost your credit if necessary.