How to compare loan offers: look past the headline rate

To compare loan offers fairly, put them on the same footing: the same amount, then the monthly payment, the total interest, every fee, and the total you will repay. The offer with the lowest headline rate is not always the cheapest, because fees and the length of the loan change the total. The loan comparison calculator lines up three offers and highlights the one with the lowest total cost.

Total cost is the bottom line

The total cost of borrowing is everything you pay beyond the amount borrowed: interest plus fees. It answers the real question, "how much does this money cost me?", in a single figure. The monthly payment answers a different question, "can I afford this each month?", and both matter. The trouble is that lenders tend to advertise whichever looks better: a low rate, a low payment or a fast decision.

Fees and the APR

Arrangement, origination or broker fees can turn a cheaper rate into a more expensive loan. A fee deducted from the loan means you receive less money but repay the full amount; a fee added to the loan means you pay interest on it. The APR exists to capture this. It is the rate at which your payments equal the money you actually receive, so it includes required fees, and the APR calculator works it out for a single offer. APR conventions differ between countries, which APR vs APY: the rate before and after compounding explains, but within one country comparing APRs over the same term is a good first filter.

The term trade-off

A longer term lowers the monthly payment and raises the total cost, because you owe the money for longer. For a 15,000 loan at 7.9% with no fees:

• over 3 years: about 469 a month and 1,897 in interest;
• over 5 years: about 303 a month and 3,206 in interest;
• over 7 years: about 233 a month and 4,576 in interest.

Stretching from three to seven years halves the payment but more than doubles the interest. Choose the shortest term whose payment you can comfortably afford, and check whether overpayments are allowed so you can repay faster if money frees up. How loan interest actually works shows how each payment splits between interest and principal.

A worked comparison

Here are three offers for 15,000, as they appear in the calculator by default:

• Bank A: 7.9% over 5 years, no fees. Payment about 303.43, interest 3,205.71, total cost 3,205.71, APR 7.90%.
• Bank B: 6.9% over 5 years with a 500 fee. Payment about 296.31, interest 2,778.65, total cost 3,278.65, APR 8.33%.
• Credit union: 7.4% over 4 years with a 100 fee. Payment about 361.98, interest 2,375.23, total cost 2,475.23, APR 7.75%.

Bank B has the lowest rate and the lowest payment, yet it is the most expensive overall once its fee is counted. The credit union is the cheapest by about 730, partly because of its lower APR and partly because of its shorter term; the price is a payment about 59 a month higher than Bank A's. If that payment is affordable, it is the better deal. If not, Bank A beats Bank B on total cost despite a higher headline rate.

What the numbers miss

• The rate you are actually offered. Advertised rates are often "representative" or "from" rates; your credit history decides the real one. Eligibility checks that use a soft search let you see likely rates without affecting your credit file.
• Early repayment charges, which matter if you might clear the loan early.
• Variable rates, which can rise during the loan; the calculator assumes fixed rates.
• Optional extras such as payment protection insurance, which add cost and are rarely required.
• Security. A loan secured on your home is usually cheaper but puts the home at risk if you fall behind.

A checklist

• Compare the same amount over the same term first, then try other terms.
• Write down every fee and whether it is deducted, added or paid upfront.
• Compare APR and total amount repayable, not the headline rate.
• Check the monthly payment against your budget, with room to spare; the debt-to-income calculator shows how much of your income debts already take.
• Read the terms on early repayment, overpayments and missed payments.

For the full repayment schedule of the offer you choose, the loan calculator shows every month. The comparison calculator stores nothing, and it is general arithmetic, not advice on which loan is right for you.