Just as you compare prices and options when shopping for a car, it is important to comparison shop for a loan. Along with the various types of loans available, each lender offers different terms, rates, and fees that affect the cost of the loan. The amount of interest you pay depends on three things: the amount borrowed, the interest rate, and the term or length of the loan.
- A fixed APR is a specified percentage rate that does not change during the life of the loan. Most vehicle loans and mortgages have a fixed APR.
- A variable APR is usually specified as a certain percentage over a moving index, such as the Wall Street Journal Prime Rate. Some credit cards, home equity loans/lines of credit, and mortgages have a variable APR. Monthly payments on variable rate loans can fluctuate, so it is important to understand the loan agreement when considering this type of loan.
The term is the amount of time allowed to repay the loan. Monthly payments, including principal and interest, are predetermined at a set amount to extinguish the debt by the end of the term. Most lenders allow you to pay off the loan early without penalty.
Although a longer term means lower payments, it also means you will pay more interest over the life of the loan. While affordable payments are an important consideration when selecting a loan term, other factors to consider are the total amount of interest paid, how long you will keep the financed item, and its value at the end of the term.
To demonstrate how the term affects the cost of a loan, let’s look at an example.
Hannah is shopping for a new car. She has $2,000 for a down payment and wants to keep her monthly payments under $500. Hannah compares loan amounts and terms on the chart below.