What Makes Up the Total Cost of a Loan?
The total cost of a loan is the full dollar amount you pay over the life of the loan, including the original amount borrowed, interest, and all fees. This figure goes beyond the monthly payment and gives you a clear picture of what borrowing truly costs.
The main components are:
Principal: the amount you borrow, which you repay over the loan term.
Interest: the lender's charge for lending you money, typically expressed as a percentage of the loan amount.
Fees: upfront costs such as origination fees or closing costs, plus any ongoing fees, that you pay to get and maintain the loan.
- Principal is the amount you borrow and must repay.
- Interest is the lender's charge for lending money, usually expressed as an annual interest rate; the APR includes that rate plus fees.
- Fees can include origination fees, closing costs, and ongoing charges like annual fees. These add to your total cost.
Sources: Consumer Financial Protection Bureau, Crestmont Capital, Wells Fargo
How to Calculate Total Interest Using the Payment Formula
To find the total interest you'll pay, you first need to know your monthly payment. The standard loan payment formula is:
M = P [r(1+r)^n] / [(1+r)^n - 1]
Where: M = monthly payment, P = principal (loan amount), r = monthly interest rate (annual rate divided by 12), and n = number of payments (months).
Once you have the monthly payment, you can calculate total interest using: Total Interest = (Monthly Payment × Number of Payments) - Principal.
- The formula assumes a fixed interest rate and a fixed term.
- The monthly interest rate is the annual rate divided by 12.
- Multiply your monthly payment by the number of payments to get the total paid, then subtract the principal to find total interest.
Sources: Bankrate, Crestmont Capital
How Upfront Fees Affect Total Cost
Upfront fees, such as origination fees or closing costs, are added to the total cost of the loan. These are not included in the monthly payment formula but must be paid when you take out the loan.
The Annual Percentage Rate (APR) reflects both the interest rate and these fees, averaged over the loan term. Because APR includes fees, it gives you a better way to compare the true cost of different loans than the interest rate alone.
- APR includes the interest rate plus additional fees spread over the loan term.
- When comparing loans, use APR to get a more accurate picture of total cost.
- Upfront fees add to the total amount you pay, even if your monthly payment doesn't change.
Sources: Crestmont Capital, Wells Fargo
Example: $20,000 Loan at 6% for 5 Years with $500 Fees
Let's walk through a complete example.
First, compute the monthly payment using the formula: M = 20000 × [0.005(1.005)^60] / [(1.005)^60 - 1] ≈ 386.66.
Sources: Bankrate, Crestmont Capital
Comparison Table: Loan Terms and Total Cost
The table below illustrates how the length of a loan term affects your monthly payment and total cost. These examples are based on a hypothetical $15,000 loan at 7.75% APR.
| Loan amount | APR | Term | Monthly payment | Total cost |
|---|---|---|---|---|
| $15,000 | 7.75% | 10 years | $180.02 | $21,602.40 |
| $15,000 | 7.75% | 5 years | $302.35 | $18,141.00 |
| $15,000 | 7.75% | 3 years | $468.32 | $16,859.52 |
Sources: Wells Fargo
Frequently asked questions
What costs should I consider beyond the interest rate?
Beyond the interest rate, you should consider fees such as origination fees, closing costs, and any ongoing fees like annual maintenance charges. These fees add to the total cost of the loan and are included in the APR, which gives a more complete picture of what you'll pay.
Sources: Crestmont Capital, Wells FargoHow do points or origination fees affect my APR?
Points or origination fees are upfront costs that are included in the APR calculation. APR spreads these fees over the loan term, so it reflects the true annual cost of the loan, including both interest and fees. This makes APR a better tool for comparing loan offers than the interest rate alone.
Sources: Crestmont CapitalIs the total cost the same as the loan payoff amount?
No. The total cost of a loan includes all payments you'll make over the full term, plus any upfront fees. The payoff amount is the amount needed to pay off the loan early, which may be less than the total cost because you avoid future interest. The total cost is what you pay if you follow the original repayment schedule.
Sources: Crestmont CapitalSources
- Loan estimate explainer — Consumer Financial Protection Bureau
- How To Calculate Loan Payments And Costs - Bankrate — Bankrate
- How to Calculate Total Loan Cost: The Complete Guide for Business Owners — Crestmont Capital
- Understand the Total Cost of Borrowing - Wells Fargo — Wells Fargo