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The True Cost Of Borrowing

In our second look of the week at borrowing, and its implications, we examine the true cost of borrowing. Borrowing is a vital tool to us all, but it is important that those that take on credit understand what they are doing. By understanding what is involved, they are much less likely to run into difficulties.

The True Cost Of Borrowing – Definition

The true cost of borrowing takes various factors and events into account. It must consider firstly the amount of the loan in question. It also must factor in the total fees added onto that amount. Then we must consider the frequency and length of repayments, and the interest rate applied to the line of credit. By looking at these factors we can ascertain the total amount to be repaid, how the repayments break down over time, and thus the true cost of the debt.

Deciding the loan amount

Before you go ahead and borrow funds, there are some important questions you need to consider. As mentioned in the last article, you must decide whether the loan is really needed. In other words, consider what it will be used for.  Also ascertain if you can raise the required capital another way. Perhaps by saving up. Then decide no how you can make repayments, fitting them into your monthly budget.

How long do you need to borrow the money for?

Longer-term loans with lower monthly repayments might seem more appealing, but they are far from ideal. They often result in you making a much larger total payment, even if the strain on your monthly finances is less as you stretch out payments. You need to balance paying off the loan as soon as possible with avoiding overstretching yourself financially. 

The True Cost Of Borrowing – Don’t just pay the minimum payment

So-called ‘minimum payments’ on credit cards can be a debt trap. By paying off a minimum, and then having new interest charges added on, you never lower the debt. In fact the debt increases despite you making regular payments. Often the minimum payment is a percentage of your outstanding balance. Thus, as your debt increases, your payments increase even though you are making regular payments every month.

The True Cost Of Borrowing – How often will you need to make repayments?

If you choose to repay a loan in one lump sum rather than make regular repayments, you’ll typically end up paying more in interest. Make sure you understand the APR, which stands for ‘annual percentage rate of charge’ and includes arrangement fees and charges. You can utilise the rate to compare various credit and loan deals. One of the easiest ways to do this is by using a price comparison website. The lower the APR, the lower the cost of borrowing, and therefore the better the deal. Lenders merely have to offer the advertised APR to just over half (51%) of borrowers they lend to.

Remember Fees

Fees might not feature prominently in the headline quote when you search for credit on comparison sites. However, it’s vital to examine the possibility of such fees,. These could include fees for late payment, default, or settlement charges and more. Such charges can hugely effect the total cost of credit.

 

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