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The Most Important Thing To Know About Loans Before Borrowing Money From A Bank

Updated on July 17, 2012

The most important thing that you need to know before getting a loan from the bank is how much money you will be paying to the bank in the form of interest. While the banks don't charge as much interest as a loan shark, you might be rather unpleasantly surprised over how much of the money you pay to the bank is for the repayment of the loan, and how much is actually the interest.

Let's assume a loan of $50,000 over a relatively long period of say 20 years at an interest rate of 5%. The amount that you need to pay the bank each month would be somewhere in the region of $329.00.

Which means that after 20 years, you would have paid the bank $329.00 X 12 months X 20 years = $78,960. If we were to take into account the interest you would have made if you had put the money in a bank (1% interest compounded monthly), then after 20 years, the total figure would be $87,442.46.

In other words, $37,442.46 or about 75% of $50,000 went to the bank in the form of interest. Looking at it another way, of the $329 that you pay the bank monthly, $156.01 or 47% goes to servicing the interest.

It is even worse for the early years. Lets say that you have paid the first month's installment of $329.00. The bank will deduct $329.00 from your loan amount, and add the interest for that month. So, after the first month, you will owe the bank:

Loan amount (after 1st month) = ($50,000.00 - $329.00) X (1 + 0.05/12) = $49,877.96

After the first month, your loan amount would have gone down by ($50,000.00 - $49,877.96) or only $122.04. In other words, $206.96 or 63% of your installment went to paying your loan!

In short, a lot of money that you pay to the bank goes towards paying for the interest of the loan, probably very much more than you expect.

To pay less interest, try to reduce the loan amount and/or the loan period. And do shop around for the best interest rate.

Or, even better, seriously look into your need for the loan. Maybe you could delay the purchase, or make alternative arrangements that does not require you to take up a loan.


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