Note that the previous example offered a simple example of the cost of borrowing $2,000. The full loan was repaid at the end of the loan term at the given interest rate. This is rarely how loans are calculated, however. With most loan terms, you make monthly payments on the loan, with some of the principal paid back with each payment. When you lower the principal owed, you lower the amount of interest paid over the life of the loan. So, the faster you pay back a loan, the less total interest you will pay over the life of the loan. Let's take another look at that cost of a $2,000 loan based on making monthly payments:
|Loan amount||APR||Length of loan||Monthly payment||Interest paid||Total cost of loan|
For the two-year loan, with a $92.28 monthly payment, the actual total interest you would pay would be $214.72. If you increased the loan period to four years, you would pay only $50.72 per month, but the total interest paid would increase to $434.56.
The total cost of credit—that is, borrowing money—changes with
• the interest rate and/or
• the number of monthly payments.
A lower interest rate and fewer monthly payments will reduce the cost of a loan.