The cost of borrowing

What borrowing actually costs you.

Most people size up a loan by its monthly payment. I'd argue that's the least useful number here. Much of it is principal: money moving into something you own. Interest is the only part that's truly gone, and the loan's length quietly decides how much.

The reasoning

Why interest, and not the payment

A loan payment is really two payments. Principal pays down what you borrowed; it moves money from owed to owned, so it stays in your net worth and isn't a cost. Interest is the rent you pay on borrowed money, and it's the only part that's truly gone. If you compare loans by their payment, you're mostly comparing how much forced savings each one bundles in. Compare them by total interest, and you're comparing what they actually cost.

Why a longer term is rarely the bargain it looks like

The payment drops because the principal is spread thinner, but you also carry the balance longer, so more interest builds up on it. You end up with a lower payment and a higher cost at the same time.

Why fees raise your rate

Points and fees are sneakier. You pay them at closing, so less cash reaches you while the balance you owe interest on stays the same. The rate on the paperwork understates the rate on your money. That gap is the effective APR, and it's the number worth comparing across offers.

Borrowing can absolutely be worth it. Just price it by what's gone, not by the payment.

About this model

The cost of borrowing: the short answer

Take a $30,000 loan at 6.9% APR over 72 months. The payment is only $510 a month, but you'll pay $6,722 in interest. Add $900 in upfront fees and the total cost of borrowing rises to $7,622, which lifts the effective APR from 6.90% to 7.99%. Shorten the same loan to 48 months and the payment goes up to $717, but total interest drops to $4,416.

Figures use the model's default inputs, stated in the text. Estimates only, not financial advice.

How the model works

The Outflow cost of borrowing model splits every loan payment into principal and interest. Principal moves money from owed to owned, so it stays in your net worth. Interest is the part you actually spend, so the model reports the cost of a loan as total interest plus any upfront points and fees.

It works month by month, assuming a fixed rate and equal payments. On the default $30,000 loan, 34% of the first payment is interest; by the last payment, it's 1%. The model also reruns the same loan at terms from 24 to 84 months, so you can see the trade-off directly: a longer term lowers the payment while lifetime interest climbs, from $2,204 at 24 months to $7,910 at 84 months.

Points and fees are paid at closing, which means the cash you actually receive is smaller than the balance you pay interest on. The rate on your real cash is higher than the rate on the paperwork. That higher rate is the effective APR, and it's the number I'd compare across loan offers.

Questions

Frequently asked questions

Is a lower monthly payment a cheaper loan?

Not necessarily. On a $30,000 loan at 6.9%, stretching the term from 48 to 72 months lowers the payment from $717 to $510 a month, but total interest rises from $4,416 to $6,722. A lower payment usually means a longer term, and a longer term means more interest.

What is the effective APR?

It's the interest rate on the money you actually receive. Upfront points and fees shrink the cash that reaches you while the balance you owe stays the same, so your real rate is higher than the sticker rate. A $900 fee on a $30,000, 72-month loan at 6.90% works out to an effective APR of 7.99%.

Why doesn't the model count principal as a cost?

Paying down principal reduces what you owe, so your net worth doesn't fall when you pay it. That's why the model only counts interest, points, and fees as the cost of borrowing.

How are points handled?

Points are entered as a percentage of the amount borrowed and treated like any other upfront fee: they reduce the cash you receive, which raises the effective APR.

What does the model assume?

A fixed interest rate and equal monthly payments for the full term. It's an estimate, not financial advice.