Loan payment, term and interest: a small payment can be expensive
How do the interest rate and term change the payment and total interest cost?
A loan payment needs to fit the monthly budget, but says little about the total cost of borrowing. Compare payment, term and remaining debt together: any one of them alone can create a misleading impression.
The payment’s components change over time
With a level-payment loan, interest is first charged on the remaining balance. The rest of the payment reduces principal. As outstanding debt falls, the interest component shrinks and the principal component grows. The following comparison assumes a fully repaid loan with monthly payments and an unchanged nominal annual borrowing rate.
One additional percentage point of interest
Example: €20,000 over 60 months, without fees. At a 5% nominal annual rate, the calculated monthly payment is €377.42; at 6%, it is €386.66. Interest costs rise from €2,645.48 to €3,199.36. Totals use the internally unrounded model payment; a contract rounding payments to cents can require a different final payment.
A longer term is not a discount
For the same €20,000 at 5%, extending the term to 84 months reduces the payment to €282.68. Interest costs instead rise to €3,744.97. This eases the monthly budget but extends the period during which interest accrues on outstanding debt. Also consider whether the financed purchase will still be in use when the last payments fall due.
Three rules for a fair comparison
Keep amount and term constant when comparing rates. Keep amount and rate constant when comparing terms. If a balloon payment is planned, explicitly include it in the total and assess whether you can pay it later. A low regular payment with a large final sum is economically different from a fully amortising loan.
Move from the model to the offer
The nominal borrowing rate used here explains the payment calculation. Actual consumer-loan offers also require the annual percentage rate under section 16 of Germany’s PAngV, which includes further prescribed costs. Check total amount payable, rate-fixing period and extra payments too. Sustainable borrowing needs a budget buffer; the mathematically largest possible payment is not a robust household plan.
A longer term buys lower monthly payments with additional interest. Compare the same loan amount and pay attention to the balance at the end, not just the visible payment.