Borrowing money is convenient, because it means we can buy what we want, when we want it, without having to wait to save up the full amount. However, whenever you borrow to buy a house, a car or even a television, you need to think about the true cost of that item, and that goes well beyond the sticker price.
The Real Cost of Borrowing Money to Buy a House
The average house price in the US in 2011 is $272,200 and the median price is $222,600 so let’s say you are buying a house worth $250,000 and you are taking out a mortgage to do so. With an average annual percentage rate of 4.8% which accounts for the cost of rates, points, private mortgage insurance and other lending costs, your home loan would look like this:
• Loan amount $250,000.
• Loan term 30 years.
• Monthly repayment $1,311.
• Total interest paid over the life of the loan is $222,200.
• When you borrowed money to buy your house, you increased the cost to $472,200.
When you borrow money to buy a house, you pay almost double the purchase price over the term of the loan. However, you are able to cut the costs of borrowing to buy a home in a number of ways.
If you make additional repayments to your home loan, you reduce the principal amount owing, and therefore less interest is charged to you. for example, if you were to pay just an extra $100 each month on the above loan, you would save more than $36,000 in interest and 4 years and 3 months off the term of your loan.
You should also make sure to find the cheapest interest rate on your mortgage at the time you apply, because even an interest rate which is just half a percent more can cost you in the long term. For example, if you took out the above loan with a 5.3% interest rate, your monthly repayments would jump to $1,388 and the total interest you will have paid will be $249,775. This means the total amount you will have to pay back will increase to $499,775.
Using an offset account in conjunction with your home loan can also save you on the costs of borrowing. An offset account is a transaction account linked to your home loan, where you can deposit all of your income and other savings. The balance in your offset account reduces the loan amount which attracts interest. For example, if your loan is for $250,000 and you have $10,000 in your offset account, you are only charged interest on $240,000.
The Real Cost of Borrowing Money to Buy a Car
Most of us spend just as much time in our cars, as we do in our homes, so it makes sense that you would want to buy a car which is a nice place to be. Therefore, if you were to spend $20,000 on a new car, and sought financing to make the purchase:
• Your interest rate is 9%.
• You will pay sales tax of $1,400.
• There will be additional fees of $40.
• The total purchase price of the car has gone up to $21,440.
• You make a down payment of $1,500 which brings your loan amount down to $19,940.
• Your repayments over the 48 month loan term are $496.
• During your loan term you will have paid $3,878 in interest.
• This means the total cost of borrowing to buy a new car is $23,818.
To save on the cost of borrowing to buy a new car, you can trade in your old vehicle. This reduces your loan amount, and therefore also reduces the amount of interest you pay on your car loan. For example:
• Your interest rate is 9%.
• You will pay a sales tax of $1,050.
• There are additional fees of $40.
• This means the total purchase price of the car is up to $21,090.
• You make a down payment of $2,500 which comprises your $1,500 cash, and the $1,000 difference between the trade in price, and the amount owing on your previous car loan.
• This means your loan amount is now $18,590.
• Your monthly repayments are $462.
• During your loan term you will have paid $3,615 in interest.
• This means the total cost of borrowing to buy a car when you have a trade in is $22,205.
• That is a saving of over $1,600.
The Real Cost of Borrowing Money to Buy a Television
There are so many great new things you want for your home when you go to a department store, that many businesses will now offer in store finance options, so you can take your purchases home on the spot, and pay them back over time.
In store finance is one of the highest interest forms of borrowing, so the true cost of borrowing money to purchase a $3,000 television for example, can be:
• A $3,000 purchase price.
• A 19% interest rate.
• A loan term of 4 years.
• Your monthly repayments are $89.70.
• Over the loan you will have paid over $1,305 in interest.
• This means the real cost of your television was over $4,300.
However, if you are able to pay off your in store finance sooner, with a loan term of just three years, you will make monthly repayments of $109.97 and pay just $958 in interest. That is a saving of almost $350 in just one year.
Many in store finance offers will also offer you an interest free period promotion, where your purchase does not attract any interest for the first 12 months for example. If you can find this type of finance, and pay $250 each month for 12 months, you will have repaid the television in full and it will have cost you $0 in interest.
Therefore, while borrowing money is an inevitable course of action when we want or need things in our lives, there are ways to reduce the cost of borrowing, and bring the true cost of our purchases back in line.