How Much Will a Loan Ultimately Cost?

It can be so easy to get into debt if you’re not paying close attention to your finances. Getting loans to pay for large purchases or expenses, using credit cards for convenience or to pay for things you don’t have money for right now — this can add up to a lot of unexpected debt. At first glance, this may not seem to be a bad thing, but by looking more closely you’ll see that by making the minimum payment on your accounts each month, you never seem to get ahead financially. To understand why, you need to take a look at the real cost of debt in order to take control of your financial health.

How interest affects your overall debt

The first thing to consider is how much money you’re paying every month — and every year — in interest on your accounts. This, of course, depends on the interest rate on your loans or credit cards. The lower the interest rate the better off you’ll be, but even paying lower interest rates on account balances can add up.

Here’s an example. Let’s say you have a loan with a $2,000 balance and you make the minimum payment due every month (2 ½ percent of the balance or $50). If you have a ten percent annual interest rate on the loan, it will take 12 years to pay off the debt, plus you’d pay almost $900 in interest above the original $2,000 balance.

The same $2,000 loan balance with an 18 percent interest rate would take more than 18 years to pay off and cost $2,600 in interest. Ultimately, to pay off the original balance of $2,000, you’d end up paying $4,600 to pay off the debt.

Paying more than the minimum due

The importance of paying as much above the minimum payment due as possible becomes clear when you calculate the true cost of carrying balances on your accounts. Let’s see how quickly you could pay off a balance and how much money you’d save by paying more than the minimum due each month.

In the first example, you have a loan with a $2,000 balance and a ten percent interest rate. Instead of paying only the minimum, pay an additional $25 toward the balance every month (for a total of $75). In this scenario you’d pay off the debt in just 31 months and pay $271 in interest. This approach would pay the debt nine years faster and save over $600 in interest.

Let’s look at the second example. If you pay $75 a month toward a $2,000 balance for a loan that has an 18 percent annual interest rate, you’d pay off the account in 35 months at a cost of $575 in interest. This would pay off the debt 15 years faster and save you more than $4,000 in interest.

Based on these examples, it’s obvious how important it is understand the real cost of debt and that just by paying a little extra each month toward your account balances, you can be in much better shape financially.