Costs of a Loan
To use either installment or revolving credit to your advantage, you'll want to understand what your loan will cost—including how interest rates are set, how your payments are calculated, what fees may apply and when the loan will be paid off. While lenders will explain these features of a loan to potential borrowers, educating yourself about how loans work before you borrow can help you make an informed decision about using credit.
The interest rate you pay on a loan is so important because it impacts not only how much borrowing will cost you, but also how much your payments will be.
Fixed vs. variable rate loans
Another feature of loans that impacts the cost of borrowing is whether the interest rate is fixed or variable. Installment loans and lines of credit may have either fixed or variable interest rates, although variable rates are more common than fixed rates on revolving loans. Each way of calculating the interest due has its own benefits and drawbacks.
A fixed rate means that the interest rate is set once and remains the same over the life of the loan. On loans with fixed interest rates, the repayment of principal and interest is calculated based on the fixed interest rate, and therefore, means that the monthly payment will remain the same over the term of the loan.
For example, a five-year $15,000 loan with a 7.00% fixed interest rate would result in a monthly payment of $297.02. This payment amount would not change for the full five years, at which point the loan will be paid in full (assuming all payments were made on time). Having a payment that fits within a household budget and does not change provides many borrowers with peace of mind.
A variable rate loan, on the other hand, means the interest rate is not fixed, but can vary, at certain points within the term of the loan. This means the monthly payment can change as well. An obvious benefit of variable rate loans is that when interest rates in general are heading lower, monthly payments on loans with variable rates are also likely to be lower. However, in times of rising interest rates, a loan with a variable rate can also mean higher payments. For some borrowers, the possibility of having lower payments isn't enough to outweigh the risk of someday having higher payments and the uncertainty of how that may impact their household budget in the future.
If lenders offer both types of rates for the same loan, they can help you understand the advantages and disadvantages of each as well as determine which meets your needs better. One thing to keep in mind is that not all installment loans have fixed rates, just as not all revolving loans have variable rates. When in doubt, ask about the type of rate you have.
Secured vs. unsecured loans 
Installment loans and lines of credit can either be secured or unsecured. If a loan is secured, it means that the lender requires you to provide something of value as collateral to back up your promise to repay. If you default, or fail to pay, the lender can take the collateral and use its value to offset what you owe. Car loans and home equity loans are examples of secured loans. The car or the home is the collateral.
Secured loans often have lower interest rates than those of unsecured loans, which don't require collateral. Lenders charge a higher interest rate on unsecured loans because they are taking a greater risk of losing money if you default on the loan. Student loans and credit cards are examples of unsecured loans.
Other costs of credit
In addition to the interest you'll pay, there may be other costs associated with using installment or revolving credit.
Some of these costs are fees you have to pay as part of the process of applying for a loan. They could include:
- Underwriting or application processing fee
- Credit check or credit report fee
- With some types of loans, appraisal, title search and title insurance fees
Other costs, such as annual or maintenance fees and payment processing fees, may be charged regularly during the term of the loan. Some but not all lenders impose these fees.
Additionally, there are fees that apply only in certain situations. You can probably avoid many of these costs if you keep careful track of how you manage your borrowing.
- Over-limit fee (the charge you may owe if you exceed your credit limit on a credit card or line of credit)
- Returned check fee (if a payment you make to your lender is not paid by your bank because you don't have enough in your account to pay the check)
- Late payment fee (if your payment does not arrive by the date it is due)
- Balance transfer fee (to move money from one of your accounts to another)
- Cash advance fee (for withdrawing cash from your credit card line of credit)
Interest rate vs. APR
A loan's interest rate is the percentage that is multiplied by the loan balance to calculate the amount, in dollars, that you pay in interest to borrow. A loan's annual percentage rate (APR), on the other hand, is the percentage of loan principal that represents the total cost of borrowing for one year. The APR includes interest and certain fees, such as application and credit check fees, but not late fees, over-limit fees or similar charges. A loan's APR may be higher than its interest rate.
Remember, when you're comparing loans, to look at the APR, not just the interest rate. You'll also want to check which fees apply and how much they are.
Financial fitness is as important as physical fitness.
