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How to work out the true cost of borrowing

When you’re planning to borrow money, it's important not to just focus on the product with the lowest monthly repayment. Before you sign up, it's important to know the total cost of repaying what you borrow.

What’s the ‘true cost of borrowing’?

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Working out the true cost of borrowing means taking into account:

  • the amount you want to borrow
  • the cost of any fees you might have to pay
  • the frequency of repayments – for example, weekly or monthly
  • the length of the borrowing ‘term’ – the time period you’ve agreed to repay what you borrow
  • the rate of interest you’ll be charged.

Taking note of all these things will help you get a picture of the total amount you’ll have to pay to the lender.

Deciding on the loan amount

Before you go ahead and borrow any money, there are some important questions you need to ask yourself:

  • Do you really need to spend the money you are planning to borrow?  
  • How much can you afford to repay?
  • Could you save up or use savings instead of borrowing?
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How long do you need to borrow the money for?

Make sure you choose the shortest term you can manage

Longer-term loans with lower monthly repayments might seem more appealing, but they’re far from ideal.

Your total cost of borrowing is likely to be higher because you’re taking longer to clear the loan and paying more interest overall. As long as the interest rates are comparable, it’s better to opt for a shorter loan term and pay back more each month if you can afford to.

In the example below, you’d end up paying back £677 more if you go for the five-year term rather than the three-year term.

Loan term
Amount borrowed
APR
Monthly repayment
Total amount to repay

3 years

£5,000

11.72%

£165.40

£6,631

5 years

£5,000

11.72%

£110.52

£7,298

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How often will you need to make repayments?

Choose regular repayments over lump sum payments

If you choose to repay a loan in one lump sum at the end of the loan term rather than making regular repayments, you’ll typically end up paying more interest.

Work out the interest you’ll have to pay

Make sure you understand the APR

Interest is usually expressed as APR, which stands for ‘annual percentage rate’. It refers to the total cost of your borrowing for a year. This is more than the interest rate itself because it includes the interest rate plus any arrangement fees.

You can use APR to compare different credit and loan deals – for example, by using a price comparison website.

Generally, the lower the APR, the lower the cost of borrowing and therefore the better the deal.

Remember to take fees into account

It’s important to check for fees in your terms and conditions – such as late payment, default, or settlement charges.

Don’t just pay the minimum payment on credit cards

So-called ‘minimum payments’ on credit cards can be a debt trap if not managed properly.

The minimum payment is the lowest amount you have to pay every month to avoid a penalty.

The amount of the minimum payment is usually based on a percentage of what you owe, so it decreases every month as your balance reduces.

This means that it will take longer for you to pay off what you owe if you stick to only making minimum payments. And it will cost you far more in the long run.

For example, if you borrow £2,000 on a 19% APR and only pay the minimum payment every month:

  • it will take you 24 years and two months to repay it
  • you’ll pay back £4,731 in total
  • the total interest you have to repay will be £2,731.

Credit card providers must contact people who, over the last 18 months, have paid back more in interest, fees and charges than what they have paid back off what they actually borrowed.

To encourage customers to bring down their credit balances, lenders are required to contact customers to suggest higher affordable repayments. If you don’t respond, or ignore the issue, and the situation continues for more than 36 months this could lead to your account being suspended.

Find out what you can do if you’ve been contacted by your credit card provider about persistent debt.

If you’re already struggling with debt it can be hard to know where to turn. But with lots of free advice services available across the UK, you can find help in a way that’s best for you.

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Looking for us? Now, we’re MoneyHelper

MoneyHelper is the new, easy way to get clear, free,
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Whatever your circumstances or plans, move forward with MoneyHelper.

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Looking for us? Now, we’re MoneyHelper

MoneyHelper is the new, easy way to get clear, free,
impartial help for all your money and pension choices.
Whatever your circumstances or plans, move forward with MoneyHelper.

Continue to website
Looking for us? Now, we’re MoneyHelper

MoneyHelper is the new, easy way to get clear, free,
impartial help for all your money and pension choices.
Whatever your circumstances or plans, move forward with MoneyHelper.

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