For consumers who wish to borrow money the single most important piece of information is the cost of borrowing, or the rate interest the consumer must pay. How much interest is payable or the actual cost of borrowing depends on a few different parameters:
1. The amount borrowed
2. The fees charged by the lender
3. The duration of the loan (for how long the borrower is taking a loan for)
4. The frequency of repayments
5. The credit history of the borrower (and perceived reliability of the borrower)
How these parameters affect the cost of borrowing is quite obvious. The larger the amount borrowed, the greater the rate of interest rate. Clearly the higher the fees charged then the greater the cost of borrowing. Contrastingly by making more frequent payments to service the debt, or reducing the period or term of the loan, results in a lower cost of borrowing.
By understanding how time and credit are related, consumers can devise many ways to reduce the cost of servicing the money they borrow from such retail products as mortgages, personal loans, credit cards and overdrafts. Here are five ideas to reduce the cost of borrowing.
1. Borrow less
Banks often coerce consumers into borrowing more than they actually need. A lot of advertising is targeted at consumers sending messages imploring them to borrow more than they require as a means of treating themselves. Obviously the more they lend, the greater the interest banks charge and the higher their profits. Therefore it makes sense to only borrow what is needed, and consumers should not make the mistake of rounding their loans upwards.
2. Reduce the interest rate
Consumers should pay cute attention to their Annual Percentage Rates (APR’s) the rough annual interest rate on their loans. Obviously the lower the interest rate, the lower the cost of borrowing. Headline APR’s however can be misleading and consumers should make the effort to check the fine print before borrowing money. If they are not sure, then they should check with the salesperson or a manager and have them explain what the true cost of debt is and how much one will actually end up paying on any amount borrowed.
3. Transfer your debt
Another way to reduce the amount of interest being paid is to transfer the debt to another lender who is prepared to offer the amount borrowed or still outstanding at a lower interest rate. One way to do this is by transferring credit card balances to a 0% balance transfer card. Doing so means that interest bills can be frozen for a year or longer. Some credit cards charge no interest for up to sixteen months provided the borrower pays a fee to transfer the debt.
Another technique that can be used it to consolidate various debts into a single loan, usually in the form of an unsecured personal loan. Before doing so consumers should be careful to check whether the consolidated loan results in a lower payment, then having many smaller loans outstanding with different lenders. In a lot of cases the larger the loan the higher the interest rate, and therefore the greater the cost of servicing the debt through a single lender. However there are many debt consolidation products out there where borrowers can sit down with advisers and try and work out whether it makes sense to consolidate. The other caveat is if a borrower chooses to go down the secured loan route, then if they fail for any reason to make payment, their properties could be threatened.
4. Make more frequent repayments
By making payments more frequently, the debt gets paid off at a faster rate, therefore bringing down the total cost of borrowing. For example, millions of American home owners prefer to pay their mortgage fortnightly, instead of monthly. By making 26 payments of half the usual monthly mortgage repayment, they make thirteen monthly repayments per year, instead of twelve.
Before changing the frequency of mortgage repayments, consumers should check with their lenders first. If they try and change the frequency of their mortgage repayments unilaterally, they may be in breach of their mortgage agreements.
5. Repay over a shorter period
Reducing a term of a loan is the easiest way to cut the cost of borrowing. If consumers can afford to pay a loan off in four years rather than five, then they should not take out a personal loan over five years simply because the option is available. That is a sure fire way to end up with a higher cost of borrowing than is required.
Credit and the cost of borrowing is a function of time, and the shorter the time period the lower the interest rate, therefore consumers should be aiming for the shortest lifespan of a loan whilst trying to balance that with an affordable repayment.
Consumers should always check their TAR (Total Amount Repayable). This metric shows the overall cost of the loan including the interest and principal plus any fees payable.