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Time is the most valuable thing any of us have to offer. We often don’t think of time when it comes to borrowing money but we should. We always see people get caught up in interest rate and while that is very important the length of time you borrow can be even more relevant.
Let me show you:
A person is evaluating a loan product and wants to pay as little as possible in interest over the life of the loan. They are borrowing $50,000 and their options are 3 years at 6% 5 years at 7 % or the newest “loan special” for 7 years at 5.49%. Doing the math we come up with:
$50,000 @ 3 years @ 6% is $1,521.10/month, total interest over loan is $4,759.49
$50,000 @ 5 years @ 7% is $990.06/month, total interest over loan is $9,403.55
$50,000 @ 7 years @ 5.49% is $718.26/month, total interest over loan is $10,334.34
Hold on! The lowest rate AND the lowest monthly payment really cost me the most money over the life of the loan? How could the 7 year option be over a ½ percent less on than the 3 year and 2.5 times the cost? How could the 5 year be 1.5% under the rate and cost almost an extra thousand? Yes it’s true assuming no additional principal payments are made. The amortization length of what you borrow has a drastic impact on costs. Essentially a shorter time frame gets the principal paid down faster and the interest that compounds is doing so on a lesser amount in a shorter time. Paying extra towards principal, especially during the earliest stages of a loan, can really help reduce total loan interest as well.
Often times it pays to peel back the layers of the onion. Sometimes what seems to make the most sense really doesn’t. It all depends on your unique situation, how much you want monthly, etc. But if saving the most when borrowing is your goal then doing it over the shortest time period possible is often the best answer.
