How Can You Reduce Your Total Loan Cost?
Short Answer
You can reduce your total loan cost by getting a lower interest rate or APR, choosing a shorter loan term when affordable, making extra payments toward the principal, avoiding unnecessary fees, and comparing offers from multiple lenders. Paying extra toward principal can reduce the amount of interest you pay and may help you repay the loan sooner.
How Can You Reduce Your Total Loan Cost?
The total cost of a loan is more than just the amount you borrow. Depending on the type of loan, your total cost can include principal, interest, origination fees, closing costs, insurance, and other charges.
For example, borrowing $20,000 does not necessarily mean you will repay exactly $20,000. If the loan has interest and fees, the amount you pay over the entire repayment period can be considerably higher.
The good news is that borrowers can often reduce their total loan cost by making careful decisions before and during the loan.
1. Choose a Lower Interest Rate
One of the most effective ways to reduce the total cost of borrowing is to get a lower interest rate.
The interest rate determines how much you pay the lender for borrowing money. Generally, a higher interest rate means you will pay more interest over the life of the loan.
Before accepting a loan, compare interest rates from different lenders. Do not automatically accept the first offer you receive.
For many loans, your credit history, income, debt, loan amount, and repayment term can affect the rate you are offered.
For example, suppose two lenders offer the same $20,000 loan:
Lender A: 8% interest
Lender B: 6% interest
If other terms and fees are similar, the lower-rate loan can result in less interest paid over time.
For some loans, especially consumer and auto loans, comparing APR can also be useful because APR incorporates the interest rate and certain additional fees.
2. Compare Multiple Lenders
Shopping around before taking a loan can help you find better terms.
Do not compare only the monthly payment. A loan with a lower monthly payment may actually cost more overall if the repayment period is much longer.
When comparing loan offers, look at:
- Interest rate
- APR
- Loan amount
- Loan term
- Monthly payment
- Origination fees
- Other lender fees
- Prepayment penalties
- Total amount you will repay
The CFPB recommends comparing important loan terms rather than focusing only on the monthly payment.
3. Choose a Shorter Loan Term When Affordable
A shorter loan term can reduce the amount of interest you pay because you repay the debt over a shorter period.
For example, a five-year loan may have a lower monthly payment than a three-year loan, but you could pay more total interest because the balance remains outstanding for longer.
The tradeoff is that a shorter term usually means higher monthly payments.
Therefore, choose a repayment period that reduces your total cost without creating an unrealistic monthly payment.
The CFPB notes that longer loan terms can reduce monthly payments but generally increase the amount of interest paid over the life of a loan.
4. Make Extra Payments Toward Principal
If your loan allows additional payments without a significant penalty, paying extra toward the principal can reduce your total interest cost.
The principal is the amount you still owe from the money originally borrowed.
When your principal balance decreases, future interest is generally calculated on a smaller balance for loans where interest is based on the outstanding principal.
However, make sure your lender applies the extra payment correctly.
For example, if your regular payment is $400 and you pay $500, ask the lender or servicer to apply the additional $100 toward the principal if that is allowed under your loan agreement.
The CFPB specifically notes that borrowers making extra payments should check how the lender applies the additional amount.
5. Pay More Than the Minimum When Possible
Making only the required minimum payment keeps the loan on its scheduled repayment path.
If your budget allows, making additional payments can help reduce the outstanding balance faster.
For example, you might:
- Add $25 to every monthly payment
- Add $50 or $100 to your payment
- Make an additional payment periodically
- Use part of a bonus or other extra income
- Round up your payment amount
Even relatively small additional payments can shorten the repayment period on some loans.
Before doing this, check your loan agreement for any prepayment penalty and confirm how extra payments are applied.
6. Avoid Unnecessary Loan Fees
Interest is not the only cost associated with borrowing.
Some loans can include fees such as:
- Origination fees
- Documentation fees
- Application fees
- Late-payment fees
- Optional insurance
- Other lender charges
These costs can increase the amount you ultimately pay.
The CFPB advises borrowers to review their loan disclosures and documents so they understand the fees associated with a personal installment loan.
When comparing lenders, consider both the interest rate and the fees instead of choosing a loan based on the advertised rate alone.
7. Improve Your Credit Before Applying
For many types of loans, your credit profile can affect the interest rate you receive.
If you are not in a hurry to borrow, improving your credit profile before applying may help you qualify for more competitive terms.
Depending on your situation, this can include:
- Paying bills on time
- Reducing existing credit card balances
- Avoiding unnecessary new credit applications
- Checking your credit reports for errors
- Paying down outstanding debt
A better credit profile does not guarantee a particular rate, because lenders consider multiple factors when evaluating an application.
8. Consider Refinancing When It Makes Sense
If you already have a loan with a relatively high interest rate, refinancing may be another way to reduce your borrowing cost.
Refinancing means replacing an existing loan with a new loan, usually with different terms.
For example, if you currently have a loan at a high interest rate and qualify for a lower rate, refinancing could potentially reduce your interest costs.
However, refinancing is not automatically cheaper.
Before refinancing, compare:
- New interest rate
- New APR
- Refinancing fees
- Remaining balance
- New loan term
- Total interest
- New monthly payment
- Any penalties for paying off the existing loan
A lower monthly payment does not necessarily mean a lower total cost if the new loan extends repayment for many additional years.
9. Avoid Extending the Loan Just to Lower the Monthly Payment
A longer loan term can make your monthly payment look more affordable, but it may increase your total interest cost.
For example, imagine two loans with the same principal and interest rate:
Loan A: 3-year term
Loan B: 6-year term
Loan B may have a much lower monthly payment, but you could pay interest for twice as long.
This is why you should consider the total amount paid over the life of the loan instead of judging an offer only by its monthly payment.
10. Check for Prepayment Penalties
Before making large extra payments or paying off a loan early, check whether the loan has a prepayment penalty.
A prepayment penalty is a fee that may be charged for paying some or all of a loan before the scheduled repayment date.
Not every loan has one, and rules can vary depending on the type of loan and applicable law.
If there is a penalty, calculate whether the interest savings from early repayment are greater than the penalty.
11. Understand APR and Interest Rate
When comparing loans, it is important to understand the difference between the interest rate and APR.
The interest rate is the cost of borrowing expressed as a percentage.
APR can include the interest rate plus certain additional fees associated with the loan.
Because of this, two loans with similar interest rates can have different overall costs.
For many consumer loans, comparing APRs can help you understand the cost of different offers more completely.
12. Be Careful With “No-Cost” Loan Offers
A loan advertised as having no closing costs or no upfront costs does not necessarily mean the costs have disappeared.
For example, a lender may cover certain upfront costs in exchange for a higher interest rate, or the costs may be added to the loan balance.
That can increase what you pay over time.
Before accepting a “no-cost” offer, compare the interest rate, fees, monthly payment, and total cost with a standard loan option.
Simple Example
Suppose you borrow $15,000.
You have two options:
Loan A:
Interest rate: 10%
Term: 5 years
Loan B:
Interest rate: 8%
Term: 5 years
If the fees and other terms are similar, Loan B will generally have a lower interest cost because you are borrowing the same amount for the same period at a lower rate.
Now imagine another situation where you can choose between:
Loan A: 10% for 5 years
Loan B: 10% for 7 years
Loan B may have a lower monthly payment, but the longer repayment period can result in more total interest.
This illustrates why borrowers should compare the total cost of borrowing rather than looking only at the monthly payment.
What Is the Best Way to Reduce Loan Cost?
There is no single strategy that works for every loan. In general, borrowers can reduce total costs by:
- Comparing multiple lenders
- Choosing a competitive interest rate and APR
- Avoiding unnecessary fees
- Selecting a shorter term when the payment is affordable
- Making extra principal payments
- Paying on time to avoid late fees
- Considering refinancing when the savings justify the costs
- Checking the loan agreement for prepayment penalties
- Comparing total repayment amounts instead of only monthly payments
Final Answer
To reduce your total loan cost, focus on the amount you will pay over the entire life of the loan rather than just the monthly payment. Compare lenders, look for a lower interest rate and APR, avoid unnecessary fees, choose a shorter repayment term when affordable, and make extra payments toward principal when permitted. These steps can reduce the amount of interest and other costs you pay over time.