Understanding the Cost of Borrowing

Most people probably understand that when they take out a personal loan, they’ll usually be asked to repay more than they borrowed, once things like interest payments are taken into account. But it’s really helpful to make sure you know the total cost of your loan at the outset, and how to work it out. It can be affected by the interest you’re charged, any fees you are required to pay and your loan term; just looking at your weekly repayment amount can give you an incomplete picture.

Here’s what you need to know to figure out how the costs work together, to allow you to easily compare loans and potentially avoid paying more than you have to.

What is the cost of borrowing?

The cost of borrowing is everything you pay in addition to your original loan amount. It includes interest you are charged over the term of your loan, as well as any fees that your lender charges. That might be fees such as establishment fees, monthly or annual account fees or fees charged if you make changes to the loan.

New Zealand has lending rules, set out in the Credit Contracts and Consumer Finance Act, which dictate that lenders must clearly disclose all the costs that borrowers will pay, including the total amount they’ll pay, before they sign the loan agreement. This gives borrowers a better picture of what they are agreeing to before they commit to the loan.

How is Interest Calculated on a Personal Loan?

Interest is a big part of your loan cost. Almost all lenders charge interest, which compensates them for lending you the money. It’s calculated at an interest rate that is either fixed or variable on your outstanding loan balance.

It’s usually the case that at the beginning of a loan term, more of your repayment goes towards paying the interest of the loan, and only a smaller portion is paying down the principal owing. Over time, as the amount you owe reduces, the interest portion of your repayment becomes smaller

It’s usually the case that the interest rate charged on a personal loan is set based on a borrower’s credit history, income, existing debt and whether the loan is secured or unsecured.

Fixed interest rates 

Most personal lending is offered with a fixed interest rate.

This means your repayment stays the same for the entire term of your loan and does not change, even if the wider interest rate market moves. A fixed interest rate means your repayment stays the same for the term of your loan, and can make it easier to budget.

Secured vs unsecured and how it affects your rate 

You may hear people talking about secured and unsecured loans. A personal loan in New Zealand can be either. When you take out a secured loan, the lender registers an interest in an asset that you own as security. This means it can sell the asset if you don’t make your repayments. This is a less risky arrangement for the lender, so you may find a secured loan has lower interest rates.

When you take out an unsecured loan, in comparison, you’re not offering anything as security. It’s a more flexible arrangement from a borrower’s perspective, but the interest rate you are offered may be higher because there’s more risk to the lender.

Lender fees

Interest is a big part of the cost of borrowing, but it’s not the only thing to consider.

You’ll also usually be charged fees for a loan that can make a meaningful difference to the total amount you repay. These can vary between lenders, so it’s very helpful to understand what you’re likely to need to pay for the loan you’re considering. Some common fees include:

Establishment fee

An establishment fee is a one-off charge that is applied when a loan is set up. It’s common for this to be anything up to about $350 in New Zealand, depending on the lender. 

Introducer fee  

If you take a loan through a financial adviser or broker, you may be charged an introducer fee.

Service fees

Some lenders charge a monthly or weekly administration fee over the life of the loan. These are charged on top of interest but can add up if you have a loan that is paid back over a number of years.

Early repayment fees 

It’s quite common for lenders to charge a fee if borrowers want to pay off their loans ahead of schedule. If you know that you’re likely to want to, it’s worth checking this before you sign.

Late payment fees 

If you miss a scheduled repayment or pay late, you may face penalty charges and default interest. If you’re concerned about your ability to repay your loan at any time, it’s important to contact your lender as early as possible. Late payment fees not only make your loan more expensive, but missing a payment can hurt your credit history.

How does the loan term affect what you pay?

Having a longer loan term can make your overall loan more expensive, even if it reduces your fortnightly or monthly payments. That’s because you have the loan for longer and are paying interest on it for longer. For example, if you have a $10,000 loan at 9.95 percent with establishment and introducer fees that add up to $495, over 24 months you’ll pay 24 monthly payments of $499 and a total of $11,976. The difference between the amount borrowed and the amount repaid is the cost of the loan.

That same loan over 36 months would have monthly payments of $349 but a total of $12,564 to repay.

Want to reduce your borrowing costs? 

There are some ways you might be able to cut the cost of your borrowing.

• Borrow only what you need – a smaller loan will cost less in interest and also mean smaller repayments.
• Choose a shorter loan term if you can afford the higher repayments – the shorter your loan term, the less chance there is for interest to accrue. The shortest term you can comfortably manage will save you money.
• Check your credit score – you may be offered a lower interest rate with a higher credit score. Are there ways you could improve your score before you apply? Making all your payments on time and correcting any errors can help.
• Check whether you can make more payments without penalty – if you’re able to pay your loan off more quickly, you may save money.

Like to chat?

If you have any questions about the total cost of a personal loan you’re considering, or just want to look at the options, get in touch with us. We’re lending experts and can answer any questions you may have.

Disclaimer: Please note that the content provided in this article is intended as an overview and as general information only. While care is taken to ensure accuracy and reliability, the information provided is subject to continuous change and may not reflect current developments or address your situation. Before making any decisions based on the information provided in this article, please use your discretion and seek independent guidance.