Curious how much borrowing will really cost before you sign up?
Don’t be like most people. Borrowing blindly is a bad move. Almost all loans are offered as monthly repayment plans. The deal is often presented like this:
“This loan lets you borrow £50,000. You’ll make 60 monthly payments of £966. That’s just £38.27 per day.”
The customer says “Sold!” and hands over their signature and cash. They’ve been tricked.
Monthly repayment is just one part of the story. How much you actually pay back and how much it costs, is something very different.
The best loan offers vs the worst can cost you thousands of pounds.
Last year, UK mortgage lending hit £1.7 trillion. Times are good in the lending industry. Can you afford not to shop around?
Contents
- Understanding The True Cost Of Borrowing
- Essential Tools For Calculating Loan Costs
- How Interest Rates Impact Your Repayment
- Comparing Different Loan Types
- Smart Techniques To Reduce Costs
- Wrapping Things Up
Understanding The True Cost Of Borrowing
The key mistake most borrowers make when considering a loan…
They only look at the monthly repayment.
The monthly repayment doesn’t tell you the full story. It’s useful, but not enough. If you want to understand exactly how much a loan really costs, you need to calculate how much you’ll pay back over the entire loan term.
Breakdown of how a loan is made up:
- Principal — how much you originally borrowed
- Interest — the cost of borrowing that money
- Fees — arrangement fees and early repayment charges
- APR — the annual percentage rate (includes interest and fees)
Add them together and you get the true cost. So if you take out a £10,000 loan at 6.5% APR over 5 years, you’ll end up paying back a total of £11,687. That means £1,687 went just on interest and fees.
Eye opening, right?
Essential Tools For Calculating Loan Costs
Don’t ever commit to a loan before you estimate your loan costs here with some basic calculation tools. There are many out there that can help you understand what you will actually pay before you sign on the dotted line.
The best loan calculators let you input your loan amount and term, instantly see the monthly repayment, compare different interest rates, and calculate the total repayment amount.
Most major lenders have their own free calculators on their websites. But don’t just stick to one — compare multiple to be sure.
Here’s why this is important:
Around 13% of UK adults say they’re considering a personal loan in the next 12 months. But most of these people won’t calculate their costs first. Don’t be that person.
Spend 10 minutes running the numbers. You’ll immediately see which offers are true good deals, and which aren’t.
How Interest Rates Impact Your Repayment
Interest rates have the biggest impact on the overall cost of a loan.
Even a seemingly small difference can have a huge impact on how much you end up paying back. Let’s look at an example:
If you borrow £10,000 for 5 years at 6.0% APR, your total repayment will be £11,555. But if your rate is 6.6% APR, that jumps to £11,714. A tiny 0.6% difference added £159 just in interest.
It gets worse with larger amounts…
The same 0.6% difference on a £25,000 loan adds an extra £397. That’s why shopping for the best rate is so important.
Interest rate will depend on:
- Your credit score
- Amount borrowed and term length
- Income and employment status
- Secured or unsecured loan
The better your credit score, the lower your rate. Lenders offer big savings to borrowers with excellent credit scores. Poor credit pays the highest rates, even on the same loan amounts.
Comparing Different Loan Types
Loans come in all shapes and sizes.
Not all are right for every person or situation. Plus each type of loan comes with different costs, terms and risks. Knowing the differences will help you to choose the best loan.
Personal Loans
Personal loans are the most common type of unsecured loans. They’re also called signature loans, as your creditworthiness is the only “collateral.”
You can usually borrow between £1,000 and £25,000, but some lenders will do up to £50,000.
Terms are fixed interest rates with repayment terms from 1-10 years. APR is wide — excellent credit could get 6% interest. Poor credit will pay 29% or more.
Secured Loans
Secured loans require collateral — some form of asset the lender can take if you can’t repay the loan.
Most secured loans in the UK use your home as the collateral. This makes them riskier, but also cheaper and larger.
Do not choose these if you risk losing your house.
Bridging Loans
Bridging loans are short term secured loans used to “bridge” a financial gap.
Bridging is commonly used when buying a property before selling another. It can also be used for other short-term funding needs.
Interest rates are high, and terms are very short — 1-18 months typical. A costly loan, but one that can be the right option for certain situations requiring quick access to funds.
Smart Techniques To Reduce Costs
Saving money is easy with these 3 simple techniques.
If you follow them, you can dramatically reduce your loan costs.
Borrow Only What You Need
This is probably the easiest one to understand… But it’s the one that most people get wrong.
Most people apply for larger loans than they really need. Lenders will happily give you £100,000 if you ask. It’s human nature to want a big loan.
Resist the temptation to borrow more. Every extra pound you borrow, you pay interest on.
Work out exactly how much you need before you apply.
Choose The Shortest Term You Can Afford
Longer terms give lower monthly repayments. But they also cost you more overall.
Pay off a loan faster to save money. You may be able to stretch your monthly budget a little to go shorter.
For example, £10,000 over 5 years at 5.8% APR costs £1,502 in interest. Make it a 7-year term and that jumps to £2,131.
Improve Your Credit Score First
Credit scores are the most powerful way to reduce borrowing costs.
The better your score, the cheaper your loan will be. Small improvements make huge differences.
Here are some tips for boosting your score:
- Pay all your bills on time
- Pay down existing debt
- Check your credit report for errors
- Register on the electoral roll
- Make sure your credit report is up to date
Give yourself 3-6 months to boost your credit score before applying. It will be worth the wait when you see the reduced interest.
Use Comparison Tools Effectively
Don’t rush into applying for the first loan you see.
Make sure you shop around and compare with multiple lenders.
Most comparison sites use soft credit searches, which do not impact your credit score at all. A soft search will show you likely rates with each lender, and take no impact on your credit.
Compare and pick 2-3 of the best deals to research in more detail.
Check Early Repayment Penalties
Some loans charge penalties if you pay off early. Typically 1-2 months’ interest.
Check the terms carefully before you sign. If there’s any chance you might pay off the loan early, don’t take a big penalty hit.
Wrapping Things Up
Don’t think calculating loan costs is rocket science…
But it is important homework before you commit.
By understanding the true cost, using some calculation tools, and following some smart tips, you can save thousands over the lifetime of a loan.
Remember:
- Don’t just look at monthly repayments
- Use multiple comparison tools to check
- Borrow only what you need over the shortest term
- Boost your credit score before applying
Take time over this decision. A loan is a serious financial commitment. The time you spend researching now will save you thousands in the future.
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