When you borrow money, your lender will mostly focus on four important aspects:
• The loan amount
• The loan term
• The interest rate
• The monthly payment
Your lender will tell you how much you are borrowing, for how long, at what interest rate, and the dollar amount you need to pay each month to keep your loan in good standing.
These are key pieces of information to know, but other factors are also important, including:
• The total interest you’ll pay
• The total cost of the loan
Knowing these two key pieces of information is important because they help you understand how much your debt is costing you. These amounts are probably a lot higher than you imagine, and they might make you think twice about borrowing money. Let’s look at how much your debt really costs you for three typical debt examples:
How Much Your Car Loan is Really Costing You
Full disclosure: I don’t think buying a new car is a smart idea, and I would never finance a new car. I feel this way because new cars lose value as soon as you drive them off the lot, and the financed amount is so high that most Canadians can’t pay it off early, which leaves them in a cycle of always having a car loan.
That said, many Canadians choose to buy a new car, and the average cost of a new car is $27,563.
Let’s look at the total cost of an average new car in the following example:
When you finance a new car, your lender will typically tell you four pieces of information, which I’ve calculated for this example:
• The loan amount ($27,563)
• The loan term (72 months)
• The interest rate (3%)
• The monthly payment ($418.78)
Your lender will probably place the most emphasis on your monthly payment. $418 may not seem so bad to own a new car, but that’s not the entire story. The whole story is that you’ll end up paying $2,589.40 in interest for this car, for a total amount of:
$27,563 + $2,589.40 = $30,152.40
Your $27,563 car will end up costing you $30,152.40. I don't know about you, but that seems like a lot of money for something that sits in a parking space 23 hours per day.
Now let’s look at another example: credit card debt.
How Much Your Credit Card Debt is Really Costing You
The average Canadian owes $2,627 in credit card debt. That may not seem like much, especially since your lender will only require you to pay a minimum payment of 2% of the balance or $10, whichever is greater. But because credit card interest rates are so high (often between 15% - 29%) your interest charges will accumulate quickly.
Let’s look at an example of how much credit card debt will cost you if you only make the minimum payment.
Let’s say you have the average amount of credit card debt ($2,627) on a credit card with a 19.99% interest rate. If you only make a minimum payment of 2% of the balance ($52.54), you’ll end up paying $9,197.69 in interest, and it will take you more than 30 years to pay off the loan.
You could use that $9,197.69 for so many things other than paying your lender!
Now for one final example:
How Much Your Mortgage Debt Is Really Costing You
It’s no secret that homes are very expensive in Canada. The average price of a home rose in January to $454,342 according to the Canadian Real Estate Association.
But with these higher prices tags also come higher interest costs. Don’t be fooled by today’s low-interest rate environment, low interest rates, when applied to large loan amounts, still equal high total interest charges.
Let’s look at how much you’ll pay in interest if you buy an average priced home in Canada.
If you purchased a home in Canada for $454,342 with a 5% down payment at today’s lowest interest rate of 2.44%, and your loan amortization (another word for the term) is 25 years, you’ll have a monthly payment of $1,990.
Over the entire term of the mortgage (25 years), you’ll pay $149,778 in interest, for a total cost of $596,941. That’s a lot of money!
Your Debt Doesn’t Have to Cost So Much
We’ve established that your debt is costing you a lot more than your monthly payment. If you’ve got a new car loan, credit card debt, or you’ve purchased a house recently, you’re probably handing over thousands of dollars in interest to your lenders. But this can be avoided, and you can put that money to better use.
By paying off your debt early, buying a used car, a modest home, and not carrying credit card debt, you could easily keep those thousands of dollars in your pocket. Instead paying that money to your lender, you could use that money to start an emergency fund, save for your children’s education, or fund your retirement.
It all starts with having an accurate picture of how much your debt is really costing you.