Comparing the total cost of credit

Resources · Cards, loans and credit · 5 min read Advanced

Key points

• The total cost of credit is everything you repay above the amount you borrowed.
• Interest rate, fees and term all change the total, not just the rate.
• A lower rate with a big fee, or a longer term, can cost more overall.
• Comparing like with like makes the differences easier to see.

What “total cost of credit” means

When you borrow, you pay back what you borrowed plus something extra. That extra is the total cost of credit:

total cost of credit = total interest + all fees

And:

total repaid = amount borrowed + total cost of credit

Two loans for the same amount can end up with very different totals. Even when their rates look almost the same.

The three things that drive the total

1. The interest rate. Higher rate, more interest each month on the same balance. No surprise there.

2. The fees. Set-up fees, monthly account fees, annual card fees, early repayment fees. They all add to what you pay. And a fee that gets added to the loan balance collects interest too.

3. The term. This is the one people underestimate. A longer term gives the balance more time to collect interest, so even at a lower rate you can end up paying more in total.

A worked example

Here are three ways to borrow $8,000. The assumptions for each:

• Interest charged monthly on the balance (monthly rate = annual rate ÷ 12)
• Fixed monthly payments, with the last payment being whatever clears the balance
• Any fee paid up front, not added to the loan

Look closely. Option C has the lowest rate, yet once you count its $400 fee it costs $131.95 more than Option A. Option B beats A on rate too, but it costs $671.01 more, because the term runs two years longer. In this example, Option A has the lowest total cost, with no fee and a shorter term.

But B has the lowest monthly payment by a wide margin. That matters if your budget is tight.

So none of them is the obvious pick for everyone. Some people put the lowest total first. Others need the lowest monthly payment to keep their budget working. It comes down to your income, your other bills and how steady things feel right now.

The maths works the same in any currency.

Rates that include fees

To make comparing easier, lenders in many countries show a rate that tries to fold some fees in alongside the interest. It’s often called the annual percentage rate (APR). In some countries a similar figure goes by another name.

Useful, yes. But they have limits. They may not include every fee, late or early repayment fees for example. They’re often based on a standard loan amount and term that may look nothing like yours. And they can’t show you what happens if you choose a longer or shorter term.

Working out the total repaid for your own amount and term fills those gaps.

Comparing different types of credit

The same idea works across different kinds of credit. It just takes a little more care.

Credit cards have no fixed term, so the total depends on how much you pay each month. Pick a fixed monthly payment and you can compare a card against a loan. Buy now, pay later may charge no interest but hit you with late fees or account fees, and those count as cost of credit too. Overdrafts may charge daily interest, flat fees, or both.

Promotional offers like 0% periods are trickier. What matters is what happens when the promotion ends. Compare the cost over the whole time you expect to owe money and you’ll get a fairer view.

A short checklist

Comparing two or more options? Write these down for each one:

• Amount borrowed
• Interest rate, and whether it’s fixed or variable
• Term, or the monthly payment you plan to make
• Every fee, and when it’s charged
• Whether extra payments are allowed without a fee
• Total repaid

Lay them side by side, like the table above, and the trade-offs usually jump out.

If you’re already struggling to cover repayments on credit you have, free debt help is confidential and free.

Common questions

What is included in the total cost of credit?

Total interest plus all fees, like set-up, monthly, annual and early repayment fees. Add that to the amount borrowed and you’ve got the total repaid.

Is APR the same as the total cost of credit?

Not quite. APR is a rate that tries to include some fees alongside interest, but it may leave some out and is often based on a standard amount and term. The total cost of credit is what you actually repay above what you borrowed.

Does a longer loan term cost more?

Often, yes, because the balance has more time to collect interest. In the example above, a lower rate over two extra years cost $671.01 more.

Try it

Put each option into the true cost calculator and see the total costs side by side. For loans with fixed payments, the loan repayment calculator gives you the monthly figure too.

General information only, not financial advice. Your situation is your own.