Loan repayments and terms

When money is tight, the smaller monthly repayment always looks like the kind option. Lenders know this, which is why the longer term is often the first thing offered. But the term of a loan is a dial, and turning it toward comfort turns the total cost up at the same time.

The same loan, two terms

Take a $20,000 car loan at 9%. Over 3 years the repayment is roughly $636 a month, and the total interest comes to about $2,900. Stretch the same loan over 7 years and the repayment drops to roughly $322 a month, which feels far friendlier, but the total interest climbs to about $7,000. These figures are illustrative, but the trade is real: the repayment halved, and the interest bill more than doubled. The extra years are not free. They are the most expensive part of the loan.

Where each repayment actually goes

Every repayment is split between interest and principal. Early in a loan, the balance is at its largest, so the interest slice is at its fattest and the principal slice is thin. As the balance falls, the split gradually reverses. This is why a borrower can pay faithfully for two years and be surprised at how much they still owe: the early repayments were mostly rent on the money, not repayment of it. On long terms, this effect stretches out for years.

Why the early years feel like standing still

Think about the very first repayment on that $20,000 loan at 9%. The interest for the month is worked out on the full $20,000, so a large slice of the payment is swallowed just covering the rent on the money, and only what is left chips at the balance. Because the balance has barely moved, the next month looks almost the same, and the one after that. Only once the balance has fallen far enough does the interest slice shrink and the principal slice swell, at which point the loan starts to melt noticeably. On a 3 year loan you reach that tipping point quickly. On a 7 year loan you crawl toward it, which is another reason the long term costs so much: you spend years in the phase where the money is mostly rent.

The trap in the small repayment

The lender who offers a lower monthly repayment is not being generous, and the smaller number is not a discount. It is the same debt, or often a larger total, spread thinner so it hurts less each month and lasts much longer. The comfortable repayment and the cheap loan are usually not the same loan, and when money is tight the comfortable one is exactly the trap. The way through is to separate the two questions: what can I genuinely afford each month, and what is the shortest term that fits inside that. Answer them in that order and the total looks after itself.

The levers you control

• Choose the shortest term whose repayment you can genuinely afford in a bad month, not the longest one offered.
• Make extra repayments when you can, and check the loan allows them without penalty before signing.
• Watch monthly account fees: a $10 monthly fee is $840 over 7 years, before any interest.
• If your income rises, resist the urge to relax. Keeping repayments the same when the minimum falls quietly shortens the loan.

What this looks like in your life

You will see this dial everywhere once you know it is there. A phone offered at $30 a month over 36 months instead of $40 over 24 is the same trick, a smaller number bought with more months and usually a bigger total. A buy now pay later plan that stretches four payments into eight is the same again. Before you pick the friendlier looking option, do the one sum that matters: monthly figure times the number of payments, plus any fees, and compare the totals rather than the monthlies.

The good debt lesson next asks whether the thing you are stretching payments on is even worth borrowing for, and the final lesson shows how a long loan ties up your income for years you might want back.