The total cost of your loan is influenced by several factors, including the principal, loan length and interest rate. When offering you a loan, lenders will check your credit score to determine the interest rate they will charge on the loan based on the loan’s other parameters such as the loan amount and length.
In this article, we will give you helpful tips on how to reduce your total loan cost, including in scenarios where you’re yet to take out a loan and are trying to get the best deal, as well as scenarios where you already borrowed money and are trying to cut down on the cost of your loan.
How to reduce your total loan cost before borrowing
First, let’s take a look at what you can do to reduce your total loan cost if you haven’t taken out the loan yet and are trying to get the best deal possible.
Increase your credit score
Arguably the most impactful thing you can do to get better deals on loans is to increase your credit score. Typically, lenders will look at your credit score to determine the interest rate – borrowers with higher credit scores get loans with lower interest rates and vice versa.
To know where you stand with your credit score, we recommend you get a soft inquiry into your credit report. In contrast to a hard inquiry, a soft inquiry does not affect your credit score. Some lenders will do a soft inquiry into your credit report when you apply for a preapproval for a loan.
Here are a few things you can do to increase your credit score:
It’s very important to make payments for all your credit accounts on time.
If possible, pay down existing debt to lower your credit utilization ratio. This is especially important when it comes to credit card debt.
Try to keep your credit card balances under 30% of your credit limit.
Limit the amount of new credit applications you make. Credit applications are accompanied by hard inquires on your credit report, which have a negative impact on your credit score.
Check your credit reports and dispute any inaccuracies you find.
Having different types of credit (for example credit cards and installment loans) can have a positive impact on your credit score.
There are quite a few credit cards on the market that are designed to help customers build up their credit score, especially for customers that have a low credit score. For more information, check out our list of the best credit cards for those with a 600 credit score.
Borrow only what you need
By borrowing a smaller amount of money, you will pay a smaller origination fee (and obviously a lower total loan cost). The origination fee is usually charged as a percentage of the loan amount – the bigger the amount you borrow, the more you will pay for the origination fee (in absolute terms).
If you’re considering taking out a loan, we provide an NPER calculator tool which can help you calculate how long it will take off to pay it off.
Take a loan with a shorter term if possible
Typically, shorter-term loans have lower interest rates than their long-term counterparts. Even if a shorter-term loan has the same interest rate as a longer-term loan, you’d still pay less interest in absolute terms.
Compare offers and negotiate
It pays to do research before taking on a loan. Ideally, you should compare different lenders as well as compare the different loan options offered by each lender. When comparing your options, it’s important to use lenders that do a soft inquiry into your credit report so that your credit score is not negatively affected.
If you're a homeowner with enough home equity, one avenue to consider is choosing a home equity loan over a personal loan. This is because a home equity loan is secured by your property, reducing the lender's risk and enabling them to offer a more competitive interest rate.
You can often secure a lower interest rate on your loan simply by negotiating with your lender. It never hurts to ask for better terms, and it can save you a significant amount of money over time.
How to reduce your total loan cost after borrowing
There are also some things you can do to reduce your total loan cost after you’ve already borrowed money.
Try to make extra payments
Making extra payments toward your loan's principal (the original amount borrowed) can lower the total amount you repay by decreasing the overall interest. These extra payments can also shorten the loan term, allowing you to pay off your debt more quickly. Additionally, it can reduce the amount of your future monthly payments.
Set up automatic bill payments
Another way to potentially reduce the cost of your loan is by setting up automatic bill payments, or autopay. Some lenders offer a slight interest rate reduction if you agree to automate your loan payments. Even if you don't receive a discount, autopay can help you avoid penalties and potential damage to your credit score by ensuring you never miss a payment.
Loan refinancing
If interest rates decline or your financial or credit situation improves during your loan repayment period, it may be beneficial to explore refinancing your loan. Refinancing could offer you a lower interest rate, reduced monthly payments, or a shorter loan term, all of which can help decrease the overall cost of your loan over time.
The bottom line
Applying the steps outlined above can help you reduce your total loan cost and save money over time. However, you should also consult with a professional before making any significant financial decisions.
If you would like to learn more on the topic of loans, we recommend you take a look at our article explaining what increases your total loan balance.