Taking out a loan to fulfil your needs like going to college or buying a car is quite common nowadays.
However, when it is time to pay back that loan, you do not have to return your loan money but you also have to pay back some interest on which you have borrowed the loan money. Paying back a loan can be quite tricky sometimes and especially when you have taken a loan to finance your college tuitions, it becomes challenging for graduating students to start their career along with paying back the loan money.
In this article, we will try to find you different methods which you can adopt to reduce your loan costs.
Factors that determine your loan costs:
Before you chalk out any strategy to reduce your total loan cost, let us first determine which factors determine your total loan cost.
Interest Rate: The foremost thing is the Interest Rate. When you borrow money from a lender, they usually charge you interest on that specific amount of loan. The interest rate is determined through an annual percentage which includes all the fees and interest.
Income and Debt: If you borrow large amount of money, let’s say for your mortgage, the lender will look at your income first and also the fact that how much of your income will go to your debt payments, be it monthly or yearly.
Credit Score: Your credit scores are a decisive factor in securing a loan. When lending out money, lenders typically assess your credit score and your ability to pay back the loan money. Based on that, they also determine the interest rate. So, if you have higher credit score, your chances to borrow loan money increase and the risk to the lender decreases as well.
Loan Terms: Loan terms are dependent on the lender and the type of loan you are borrowing. Loan terms consists of the length of loan, its fees and so on.
Let’s now move on to how can you reduce your total loan cost!
Compare different offers and do thorough Research:
Market research and comparing different offers are essential steps to ensure you make an informed decision when borrowing money. It helps you find the most cost-effective and suitable loan for your financial circumstances while avoiding potential pitfalls and hidden costs.
Loan terms can vary significantly between lenders. Comparing offers allows you to identify the loan with the lowest interest rate and fees, which can save you a substantial amount of money.
Different lenders may offer different terms, such as loan duration and repayment options. Comparing offers enables you to select terms that align with your financial goals. As far as Interest rates are concerned, they can be fixed or variable. By comparing offers, you can understand the differences between these options and choose the one that suits your risk tolerance and financial strategy.
If you’re considering multiple types of loans (personal loan, educational loan, home equity loan, credit card balance transfers), comparing offers allows you to diversify your debt portfolio, spreading risk.
Signing up for the Auto-pay option:
Auto-pay ensures that your loan payments are made on time, every time. By automating your payments, you eliminate the risk of forgetting to make a payment. Some lenders offer interest rate discounts to borrowers who enrol in auto-pay. These discounts are typically 0.25% or 0.50%, but over the life of a loan, this can add up to substantial savings.
Auto-pay simplifies your finances. You don’t have to remember due dates, write checks, or log in to make payments manually. This convenience reduces the stress of manual payment and helps you maintain better financial discipline.
By making automatic payments, you ensure that at least the minimum required payment is made each month. However, if you can afford to pay more, you can set up auto-pay to make additional principal payments, which can help you pay off your loan faster and reduce the total interest paid.
Most auto-pay programs allow you to adjust your payment amount or cancel auto-pay at any time, so you can customize your repayment strategy to meet your financial goals. This gives you a lot of flexibility in your financial decisions.
Using Tax refunds, bonuses and gift money towards your Loan:
Reducing your total loan cost takes time and discipline. While windfalls such as these can provide a boost, it’s essential to maintain a consistent repayment strategy to see significant progress in reducing your debt.
Making extra payments on your loan is an effective way to reduce the total loan cost. While it may not seem the most exciting idea, every little contribution helps. When you receive a bonus, tax refund, or gift money, consider using a portion of it to make an extra payment towards your outstanding loans. This can help you pay down the principal balance faster, reducing the overall interest you’ll pay over the life of the loan.
Refinancing your Loan:
One of the reasons why people refinance loans is to secure a lower interest rate. If market interest rates have dropped since you initially took out the loan or if your credit score has improved, you may be eligible for a loan with a lower interest rate. A lower interest rate means you’ll pay less interest over the life of the loan, reducing the total cost.
If you use the refinanced loan to pay off high-interest debt and then make timely payments on the new loan, your credit score may improve over time. A better credit score can lead to better loan terms in the future, reducing the total cost of future loans.
When graduating students start working, it usually leads to their credit score becoming better. This is when they can refinance their loans and take the option with a lesser interest rate, thus reducing the monthly payments and ultimately lessening the total loan cost.
If you have multiple loans with high-interest rates, you can refinance them into a single loan with a lower interest rate. This is common with student loan consolidation or consolidating credit card debt into a personal loan. By doing so, you can reduce the total interest paid over the life of the loans.
Choose Shorter Term:
With a shorter loan term, there is less time for interest to accrue on the principal balance. Interest is typically calculated based on the outstanding principal balance, so with a shorter term, you pay interest on a smaller amount over the life of the loan.
A shorter loan term puts pressure on borrowers to budget and manage their finances more efficiently because the monthly payments are typically higher. This can be a positive financial discipline, which may lead to fewer missed payments and less overall financial stress. However, it also depends on your financial situation as to how much monthly payment you can afford to make without constraining yourself financially.
In some cases, lenders offer lower interest rates for loans with shorter terms. Lenders may view shorter-term loans as less risky and may be willing to offer better terms, including lower interest rates. A lower interest rate means you’ll pay less interest over the life of the loan.
With a shorter term, a larger portion of each monthly payment goes toward reducing the principal balance. This accelerates the rate at which you pay down the debt. As the principal balance decreases more quickly, you’ll pay less interest over time.
When you combine the effects of lower interest rates, less time for interest to accrue, and faster principal reduction, you end up paying significantly less total interest over the life of the loan. This reduces the overall cost of borrowing.
Don’t allow Interest to capitalize on your total loan cost:
Interest capitalization is common in some types of loans, such as student loans, where interest may accrue while you’re in school and not making payments. When you enter repayment, the accrued interest often capitalizes, causing the loan balance to increase.
The most significant impact of interest capitalization is on the total amount you pay for the loan over its lifetime. You’ll end up paying more in interest charges compared to a loan where interest does not capitalize. To compensate for the higher loan balance, your monthly payments may increase, which can strain your budget.
To minimize the impact of interest capitalization on your total loan cost, consider making interest payments during any periods when they’re not required. For example, with student loans, you can make interest payments while in school to prevent interest from capitalizing. Additionally, paying extra toward your principal balance can help reduce the compounding effect of interest on your loan.
Prioritizing Federal options for Student Loans:
Federal student loans typically offer fixed interest rates, which means your interest rate remains the same throughout the life of the loan. This can provide stability and predictability in your monthly payments, making it easier to budget.
Federal loans offer income-driven repayment plans, which can cap your monthly payments based on your income and family size. This can make your payments more manageable if you have a low income.
Federal loans may be eligible for loan forgiveness programs, such as Public Service Loan Forgiveness (PSLF) or Teacher Loan Forgiveness. These programs can help you reduce or eliminate your remaining loan balance after a certain number of qualifying payments.
Most federal loans do not require a credit check, making them accessible to borrowers with limited or poor credit history. Private loans often require a credit check and may have higher interest rates for borrowers with lower credit scores.
Some federal loans, like Direct Subsidized Loans, do not accrue interest while you are in school or during deferment periods. This can significantly reduce the total cost of the loan.
The Bottom Line:
Borrowing a loan might get you out of a tough financial position but the cost of such borrowing can often become expensive. Therefore, you need to analyse all your options carefully before opting for a loan. All the above mentioned solutions can always be used simultaneously to reduce your total loan cost.
At the end, it is always about how better you manage your finances and fulfil your financial goals by keeping everything in check. Happy Borrowing!