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WalletPrep worksheet · Debt

How do personal loans work?

Name ____________________ Date __________

Key ideas

  1. Compare loans by APR, not the rate. The APR includes the origination fee. Jordan's 11% rate with a 5% fee works out to about 14.6% APR.
  2. The payment stays the same every month. Most personal loans have a fixed rate and a fixed term, so you know the exact payoff date from day one.
  3. Longer terms cost more in total. On $10,000 at 11%, 36 months costs $1,786 in interest. Stretching to 60 months costs $3,045.

Vocabulary

APR
Annual percentage rate: the yearly cost of borrowing money, shown as a percentage. It is the number to compare on cards and loans.
Credit union
A not-for-profit financial cooperative owned by its members, offering checking, savings and loans much like a bank.
Origination fee
A one-time fee a lender charges for making a loan, usually a percentage of the amount borrowed and often taken out of the money you receive.
Credit score
A 3-digit number, usually from 300 to 850, that predicts how likely you are to repay debt on time. Lenders use it to set rates.
Credit report
A record of your credit accounts, payments, balances and some public records, kept by each of the three credit bureaus.
Principal
The amount you borrowed, or the part of your balance that is still owed, not counting interest.

Work it out

Jordan needs about $9,500 for a car repair and a dental bill. He is offered $10,000 at 11% interest for 36 months, with a 5% origination fee.

  1. Loan amount
  2. Origination fee (5%)
  3. Cash Jordan receives
  4. Monthly payment
  5. Payments
  6. Total of payments
  7. Amount borrowed
  8. Interest
  9. Origination fee
  10. Total cost of the loan

Check yourself

  1. Which number is best for comparing two personal loan offers?

    • A. The monthly payment
    • B. The APR
    • C. The interest rate alone
    • D. The loan amount

  2. You borrow $8,000 with a 4% origination fee taken from the proceeds. How much lands in your account?

    • A. $8,000
    • B. $7,968
    • C. $7,680
    • D. $8,320

  3. What happens to total interest if you pick a longer term at the same rate?

    • A. It goes up
    • B. It goes down
    • C. It stays the same

Your turn

If you are thinking about a personal loan, prequalify with one credit union and one other lender. Write down each APR, payment and total of payments side by side, and pick the lowest total cost you can afford each month.

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Answer key

How do personal loans work?

Work it out

  1. Loan amount$10,000
  2. Origination fee (5%)− $500
  3. Cash Jordan receives= $9,500
  4. Monthly payment$327.39
  5. Payments36
  6. Total of payments$11,786
  7. Amount borrowed− $10,000
  8. Interest= $1,786
  9. Origination fee$500
  10. Total cost of the loan= $2,286
  1. The 5% fee comes out first: $10,000 × 5% = $500, so Jordan gets $9,500 in his account but owes $10,000.
  2. At 11% for 36 months the payment is $327.39. $327.39 × 36 = $11,786, so the interest is $11,786 − $10,000 = $1,786.
  3. Interest plus fee is $1,786 + $500 = $2,286. Measured against the $9,500 he got, that is an APR of about 14.6%, the number to compare across lenders.

Check yourself

  1. B. The APR The APR includes required fees like an origination fee, so it shows the yearly cost of each loan on the same footing.
  2. C. $7,680 $8,000 × 4% = $320. $8,000 − $320 = $7,680, but you still repay the full $8,000 plus interest.
  3. A. It goes up A longer term lowers the payment, but interest builds for more months, so you pay more in total.