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Why Interest Rates Matter on Your Loans

By: David Halverson October 31, 2022

For the past few years, borrowers have benefited greatly from a low-rate environment, taking out loans with percentage rates in the tiniest of single digits. Things started to change in 2021, however, and in 2022, rising inflation – and an aggressive Federal Reserve policy – have pushed rates up at a blinding pace. However, it can be hard to understand exactly what “rising rates” means unless you see black-and-white numbers about how much more you’ll be paying in interest. The point of this exercise is to emphasize that now more than ever, it’s essential to shop around to find the lowest possible rates available. It’s also a good idea to work with a loan specialist, who can find you alternative sources of financing that may not be readily available from a casual search. With these factors in mind, here’s a closer look at why interest rates matter on your loans.

$20,000, Five-Year Loan at 4%

Just a few short years ago, taking out even a personal loan at 4% – or even lower – was a reality for consumers with high credit scores. Unfortunately, those rates have already faded into memory and may not reappear anytime in the near future, if ever.

 

At a 4% interest rate, a five-year, $20,000 loan will have a monthly payment of $368.83. Total loan interest after those five years will reach $2,099.83.

$20,000, Five-Year Loan at 8%

At an 8% interest rate – which was more common for customers with mid-tier credit a few years ago – payments would jump to $405.53. Although the rate has doubled, the monthly payment has only risen by about 10%. However, the total amount of interest you have paid will rise by a significant amount, to $4,331.67 over the life of the loan. This is a factor that is often overlooked when comparing interest rates. Although your monthly payment will only go up by a relatively modest amount when your rate jumps from 4% to 8%, the total amount you will pay for that loan skyrockets.

$20,000, Five-Year Loan at 10%

A five-year loan at a 10% interest rate may not seem much more expensive than the same $20,000 loan at 8%. But again, it increases the total cost of your loan by a significant amount. The relatively small increase in monthly payments – from $405.53 to $424.94 – is almost sinister, as it covers up the real increase in the cost of your loan. By the end of the five-year loan period, you will have paid a total of $5,496.45 in interest. That’s a $1,164.78 increase in your interest costs with just a 2% bump in your interest rate.

$20,000, Five-Year Loan at 15%

For some customers, loan rates of 15% are already a reality, and with rates increasing as fast as they have been, even mid-tier customers may face these rates soon. At 15%, payments start increasing dramatically, and the total interest you’ll have to pay is almost hard to believe. Monthly payments jump to $475.80, which may still be manageable for many. However, over the life of the loan, you’ll end up paying a whopping $8,547.92 in interest alone. That increases the total cost of your loan by 43%, as you’ll end up paying back $28,547.92 on your $20,000 loan.

The Bottom Line

Even modest increases in your interest rate can translate to significant added interest expenses over the life of your loan. Getting your finances in order so that you have the best credit score possible is an important first step, especially in a high-rate environment. But shopping around for the lowest loan rates you can find – and even investigating alternative forms of financing – is equally critical. Using a loan specialist to guide you in the right direction can help make this task easier.

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