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Loans 101: the Basics of Borrowing

Loans 101: the Basics of Borrowing

By Mike Pugh

September 04, 2008

A Case Study

To see how all the pieces fit together, let’s take a look at a sample loan.

Karen takes out a $10,000 loan with an interest rate of 8.25 percent and a 10-year term. Because this is a secured loan, Karen uses her 1967 Ford Mustang as collateral.

Karen’s loan breaks down as follows:

Loan Balance: $10,000
Loan Interest Rate: 8.25%
Loan Term (in years) : 10
Minimum Monthly Payment: $122.65
Total Payments: $14,718.49
Total Interest Paid: $4,718.49

The minimum monthly payment that Karen needs to make to complete her loan within the 10-year term is $122.65. After 120 payments of $122.65, Karen will have paid off her entire loan and $4,718.49 in interest.

Keep in mind that Karen can always increase her monthly payments. This will shorten her loan’s term and result in less interest paid. For instance, if Karen decides to pay $250 each month, her repayment plan breaks down as follows:

Loan Balance: $10,000.00
Loan Interest Rate: 8.25%
Monthly Loan Payment: $250.00
Number of Payments: 47
Total Payments: $11,734.15
Total Interest Paid: $1,734.15

By upping her monthly payment, Karen shortens the term of her loan to 47 months, or just under four years. She also reduces the total amount of interest she pays to $1,734.15.

Let’s say that, instead of upping her monthly payments, Karen skips a few. In fact, let’s say she stops paying the loan altogether. That’s bad news for Karen. Because this is a secured loan, Karen may be kissing her Mustang goodbye.

So when you consider taking a loan, pay special attention to the basic terms to anticipate how much you’ll pay and how long you’ll be in debt.

If you want to calculate how much your loan will cost you (and how much you’ll need to make to keep pace with your payments), check out the Loan Payment Calculator.


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