Understanding the concept
A loan lets you borrow money now and repay it later. The amount borrowed is the principal. Interest is the cost of borrowing, while fees and the repayment schedule also affect the total cost.
These examples are for learning purposes, not personal financial advice. Check current terms and fees with your provider before making a financial decision.
Step-by-step method
Compare loans using the same borrowed amount and repayment period. Check the interest rate, whether it is fixed or variable, repayment frequency, fees and total amount repaid. An advertised interest rate is not the whole cost.
- Write down the principal, annual rate and term.
- Check whether the repayment amount includes fees.
- Calculate total repayments: regular repayment × number of payments.
- Subtract the amount borrowed to estimate interest and fees paid.
- Compare loans on equivalent terms and allow room in your budget for rate changes.
Quick-reference table
| Item | Example or formula | What it means |
|---|---|---|
| Principal | $12,000 | Amount initially borrowed |
| Annual interest rate | 8% p.a. | Rate stated per year; actual loan calculations may compound |
| Loan term | 3 years | Longer terms may reduce repayments but increase total cost |
| Comparison rate | Rate including certain fees | Useful for comparing eligible loans of the same type |
Four worked examples
Follow the figures and method in each example.
Example 1: Total repayments
Situation: $390 per month for 36 months
Example 2: Repayment frequency
Situation: $150 per fortnight for 26 fortnights
Example 3: Budget check
Situation: Income after essentials $650/month; proposed repayment $520/month
Example 4: Comparing terms
Situation: Loan A: $410 × 24 months; Loan B: $295 × 36 months
Common mistakes
- Comparing only the monthly repayment rather than total repayments.
- Assuming a fixed and variable interest rate carry the same risk.
- Ignoring establishment, ongoing or early repayment fees.
- Using simple interest to predict an amortising loan without its actual schedule.
Practice questions
Try each question before expanding the answer.
Question 1: A loan requires 48 monthly repayments of $275. What is the total repaid?
$275 × 48 = $13,200.
Question 2: You borrow $10,000 and repay $12,400 in total. How much above principal is that?
$12,400 − $10,000 = $2,400.
Question 3: Which is cheaper overall: $220 × 30 months or $195 × 36 months?
$6,600 versus $7,020; the first is $420 cheaper.
Question 4: Why should you compare loan fees?
Fees can increase the overall cost even when the advertised interest rate is lower.
Question 5: Why does a longer term often increase total interest?
The outstanding principal generally remains unpaid for longer, so interest may accrue over more periods.
Review checklist
- Can you explain the key terms in your own words?
- Can you reproduce the calculations with different numbers?
- Have you checked fees, units, assumptions and rounding?
- Can you explain when the method is useful in everyday life?