How to Compare Loan Terms
If you have multiple loan options, shopping for the best and cheapest loan can be complicated, and there are many different factors you’ll have to consider. With different loan terms, time limits and monthly payments, finding the best deal can take some work. There are some basic things to consider and analyze before choosing the perfect loan for you.
Loan term in years
Compare the different loan terms, and when possible, choose the shortest loan term available to you. While a shorter loan term will likely increase your monthly payments, you will find yourself paying a lower amount of overall interest.
If for some reason, the shorter loan term comes with a higher percentage rate, then you may consider taking the longer-term loan but making larger payments, as long as there isn’t a prepayment penalty.
Interest rate/Annual percentage rate (APR)
The interest rate and/or annual percentage rate (APR) is one of the most important factors to consider when determining which loan is best. For some loan types, comparing interest rates is appropriate, but the APR is a better number to review. The APR factors in fees, including points and origination fees, while the interest rate is just the basic interest charged. For mortgages, lenders are required to tell you the APR, and comparing the APRs is a better way to accurately determine which loan will cost you more in the long run. However, for variable rate loans, there’s no easy way to compare interest rates. In most cases, the comparison comes down to whether you are comfortable with the variability in interest over the loan term, as well as the current monthly payment.
Some loans have a loan term that is shorter than the amortization term. Those loans generally have a balloon payment due that is essentially the remaining money owed at the end of the loan term. If you are analyzing a loan with a balloon payment versus one that doesn’t, keep in mind that you will need to have that money available to pay when it becomes due, or you’ll need to refinance.
Total amount owed
The total amount owned includes the original amount borrowed plus interest and fees. Try to choose the loan with the least amount of money owed over the entire term, if you can afford the monthly payments.
Finally, look at the monthly payments to see the amount you’ll need to pay each month. While some loans with variable interest rates or balloon payments may provide a lower monthly payment than other loans, make sure you are not getting in over your head. If you are stretching yourself financially with an interest-only payment or other type of low monthly payment loan, re-evaluate exactly what you can afford. In general, take the loan with the lowest interest rate/APR and loan term as long as you can afford the monthly payment.