Taking out a loan can be necessary to cover big expenses like a home, car, or education. But loans also come at a cost, with interest charges that result in paying back more than you originally borrowed. The total interest paid over the life of a loan can really add up.
Luckily, there are ways to reduce the total cost of your loan and pay less in interest. With some smart strategies, you can make your loan more affordable and save money over time.
Factors That Determine Loan Costs
Several key factors go into calculating your total loan costs:
- Principal amount: The amount you borrow. The higher the principal, the more interest you’ll pay.
- Interest rate: The percentage charged on the outstanding principal by the lender. Higher rates mean higher interest costs.
- Loan term: The length of time you have to repay the loan. Longer terms result in more interest paid.
- Fees: One-time fees like origination fees or prepayment penalties also add to costs.
To get the best loan cost, you want to optimize these factors where possible through the following strategies:
1. Boost Your Credit Score
Your credit score is a key factor lenders use to determine your interest rate. The higher your score, the lower the rate lenders will likely offer you.
Before applying for a loan, check your credit reports and scores. If they are low, take steps like paying down debts and making on-time payments to improve your credit profile. Even a small score boost can mean big interest savings.
Check your credit score for free.
2. Compare Interest Rates
Interest rates and fees vary significantly by lender, so compare loan offers before committing. Get rate quotes from banks, credit unions, online lenders, and anywhere else you can qualify.
A lower rate can translate to thousands in interest savings over the life of your loan. Make sure to compare Annual Percentage Rates (APRs), not just interest rates, to account for fees.
3. Opt for a Shorter Term
Paying off your loan faster means less time for interest to accrue. See if your lender offers a shorter repayment term than the standard term.
For example, choosing a 15-year mortgage over a 30-year option means you pay the loan off in half the time. Even if your monthly payment goes up, you save significantly in total interest paid.
4. Make Extra Payments
Sending in extra payments above your regular monthly amount helps pay down the principal faster. This reduces your overall interest since you have a lower balance accumulating interest each month.
Even an extra $20 or $50 per month makes a noticeable dent over time. Some strategies:
- Add a bit more to your automated monthly payment.
- Make an extra principal-only payment each year with your tax refund.
- Round up payments to the nearest $50 or $100.
- Make biweekly instead of monthly payments.
5. Set Up Auto Pay
Enrolling in automated payments from your bank account can both ensure you never miss payments and score you an interest rate reduction. Many lenders offer discounts around 0.25% for setting up autopay.
6. Refinance Your Loan
If you secure a lower interest rate through the same lender or a new one, refinancing your existing loan can save money. You may also refinance to a shorter term to pay it off faster.
Run the numbers to see if refinancing savings outweigh any fees. Check rates every 1-2 years or whenever there are major rate drops.
7. Pay Down Debts First
Your debt-to-income ratio influences the rates and terms lenders will offer. Paying down credit cards, car loans, and other debts improves this ratio and can help you qualify for a lower rate on your next loan.
8. Negotiate Fees and Terms
Don’t be afraid to negotiate with lenders for better loan terms. Many fees are negotiable. Ask about fee waivers, discounts for autopay, loyalty perks, or simply ask if they can offer a lower rate. The worst they can say is no.
9. Use Cash Windfalls Wisely
If you receive a bonus at work, tax refund, or monetary gift, consider putting it towards your loan principal. Even a couple hundred dollars can make a difference in interest paid. Make the money work hard for you.
10. Monitor and Adjust
Check in on your loan every 6-12 months, especially if your finances improve. As your credit score rises or income increases, new options like refinancing may make sense to reduce costs further.
READ ALSO: How to Get a Business Loan: A Comprehensive Step-by-Step Guide For 2024
Strategies to Reduce Student Loan Costs
College graduates owed an average of $28,400 in student loan debt in 2020. With exorbitant college costs, student loans are unavoidable for many. Use these tips to minimize interest and repay faster.
- Prioritize federal loans over private loans whenever possible. Government education loans like Direct Subsidized Loans and Perkins Loans have lower fixed rates and preferable terms compared to private lenders.
- Sign up for auto-debit through your loan servicer for a 0.25% interest rate reduction.
- Apply for income-driven repayment plans like PAYE or REPAYE to cap payments at 10-20% of discretionary income if you’re struggling after school. These plans extend terms but provide payment relief.
- Consider refinancing or consolidating student loans through a private company like Earnest or SoFi to combine loans into one at a lower rate. Run the numbers to see if you save overall.
- Live frugally after college and put any extra income toward student loans to pay them down aggressively. The faster you repay, the less interest you pay.
How Can I Get Lower Mortgage Rates and Costs?
Mortgages tend to be large, long-term loans, so reducing interest can really pay off. Use the following tactics:
- Shop around with multiple lenders and compare loan estimates to find the lowest rates and fees. Look at online lenders, credit unions, and community banks in addition to big national lenders.
- Improve your credit score before applying for a mortgage. Work on increasing your credit score to over 740 to qualify for the very lowest rates.
- Make a down payment of at least 20% to avoid private mortgage insurance (PMI), an added cost for borrowers with less than 20% equity.
- Choose a 15-year fixed-rate mortgage instead of a 30-year loan. The faster payoff means you’ll pay significantly less in interest.
- If your credit score improves after getting your mortgage, look into refinancing for possibly lower rates.
READ ALSO: Nationwide Auto Loan Refinancing 2024 Review: Rates, Terms & Eligibility
How to Reduce Auto Loan Costs
Since cars depreciate in value quickly after purchase, you don’t want to pay excess interest on a car loan. Some savings tips:
- Shop dealer financing offers against rates from banks and credit unions. Go with whichever has the lowest APR.
- Put down a larger down payment if possible. This lowers the amount you have to finance.
- Opt for the shortest loan term you are comfortable with. A 36-month loan costs much less than a 72-month one.
- Make biweekly half-payments instead of one monthly payment to pay off your auto loan faster.
- Refinance your car loan if you find a lower rate from another lender later on. This can shave down your interest costs.
To Recap
While loans provide access to big purchases and investments, they also come with interest costs that make you pay more over time. Don’t just accept high loan costs as an inevitable fact. With some smart strategies like boosting your credit, shopping lenders, making extra payments, and refinancing, you can reduce your total loan costs and keep more money in your pocket.
Monitor interest rates and your finances consistently, and jump on opportunities to improve your loan terms over time. Every bit of interest you save is money that stays in your wallet. Do your homework upfront and remain vigilant to find the optimal loan products and terms for your needs.
FAQs On Loan Cost Reduction Strategies
How can I reduce my monthly loan payments?
Refinancing to a lower rate or extending your repayment term through your lender are two ways to potentially lower your monthly payment amount. However, realize that extending the term means paying more interest over the full loan.
What is the easiest way to reduce total loan costs?
The easiest option is to set up automated payments from your bank account. Most lenders offer a small interest rate reduction, typically around 0.25%, just for enrolling in autopay.
Can I negotiate a lower interest rate with lenders?
It never hurts to ask! Many lenders are willing to negotiate rates and fees, especially for loyal repeat customers. Have information on competitor loan offers ready to strengthen your position.
Should I pay off high-interest debt before taking out a loan?
If possible, pay off credit card balances and other expensive debt first. This improves your debt-to-income ratio, so you may qualify for a lower rate on your next loan.
How can I get late fees waived?
Contact your lender right away if you miss a payment and ask if they will waive the late fee. Especially if it is your first late payment, lenders will often waive fees for customers who have shown consistent repayment history.
In another related article, How to Get a Loan: Tips for Successful Loan Applications
