Climbing Out of Debt: How Can You Reduce Your Total Loan Cost?
Don’t let your loan cost get you down. No matter how big and looming it seems now, there are strategies you can use to tackle it.
March 16, 2022
When you’ve racked up debt, it can feel like there’s no way to escape those monthly payments that seem to stack up forever. But, once you take a step back, you might realize the right solution is reducing the amount you’re expected to pay back over the life of the loan.
So, how can you reduce your total loan cost?
Keep reading to learn how loans work, ways to reduce your loan amount and how you can approach your debt effectively.
Loans: A primer
To understand how you can reduce your total loan cost, it’s important to know how loans work.
In this article, we’ll focus on installment loans. These are loans that involve signing up for a certain balance and paying it back through monthly payments.
The following types of loans are installment loans:
Student loans (private student loans and federal student loans)
Home loans or mortgages
Unlike credit cards (or revolving loans), installments loans are a more flexible type of lending that allows you to borrow up to a fixed credit limit and carry the balance over from one month to the next.
Although the differences between the two can seem negligible when you carry both types of debt, you can’t necessarily apply the same strategies for reducing the loan value. To tackle installment loans, it’s smart to pay attention to the loan term — something credit cards don’t have.
How can you reduce your total loan cost?
Broadly speaking, there are two ways to reduce the total cost of an installment loan:
Secure a lower annual percentage rate (APR)
Pay the money back faster
When you reduce the APR of your loan, you’ll pay back less each month — meaning, over the course of the loan, the total cost will be lower.
For example, if you originally had a balance of $10,000 and an APR of 20% for a loan term of 10 years, you’d spend $13,190.68 in interest payments alone. But, if your APR was 10%, that number would drop down to $5,858.09. That’s quite a stark contrast.
Paying the loan back more quickly will also reduce the loan cost. Even if your APR of 20% remained the same, paying an additional $100 a month from the get-go would reduce the total interest paid to $4,905.02. Why? Because there would be fewer total months for the interest to continue accumulating.
That said, there are various ways to go about achieving these core goals. Here are some practical strategies that borrowers can apply to reduce their debt burden.
Choose a shorter term
If you’re still in the process of taking out your loan, you have an edge in keeping your total loan cost to a minimum. You can simply choose the shortest term possible from the get-go (e.g., choosing a five-year loan term over a 10-year loan term).
As the numbers above show, the quicker you pay your loan back, the less you’ll have to pay overall.
However, don’t take on more debt than you can afford, or you might end up with late fees. This could result in you racking up even more debt. Instead, make a budget and figure out exactly how much you can afford to dedicate to your loan each month — then work your way backward from there. Or, maybe you could increase your salary through side hustles to afford the payments.
Pay off your loan early
Already agreed to a fixed term? You might still have the ability to make extra payments, which would result in the same outcome as the scenario above.
However, watch out for prepayment penalties. Not all lenders charge them, but when they do, the numbers can be hefty. For instance, a typical penalty for paying off a personal loan in the first year is around 2% of the total balance.
Also, try not to overextend yourself. It’s better to build up an emergency fund before you go too crazy with the extra payments, so you know you’re financially secure.
Refinance your loan
Not everyone can afford to take up a shorter loan term or make extra payments, but refinancing is an accessible solution. Refinancing a loan means switching your current loan to a different lender with the aim of obtaining more favorable terms — usually lower interest rates.
If another loan company can offer you more attractive repayment options, it can lower the total cost of your loan.
However, as is the case when you apply for a new loan, the APR you’re eligible for will depend on your credit score. The higher your score, the better chance you have of a good offer.
Depending on the type of loan you have, you may also have to cover extra costs, so account for this when you’re deciding how much money you’ll save. For instance, refinancing a home loan can result in total costs of between 2% and 6% of the total loan value.
Opt for autopay
You may be able to pay slightly less interest if you enable automatic payments, meaning the loan servicer will take funds directly from your bank account on a specific date each month. It’s sometimes called an automated clearing house (ACH) discount.
This offers the lender slightly more security, which is why they’re willing to give you a small discount.
For example, student loan providers typically offer a reduction of around 0.25%. This might not be a huge number, but every little bit helps. Try contacting your loan provider to see if you’d be eligible.
Look for a loyalty discount
In some cases, lenders offer a loyalty discount to specific customers. To get one, you’ll need to meet certain criteria, such as holding another account with that lender or being a previous customer.
As with autopay, the discount is likely to be fairly marginal, but it’s worth contacting your lender if you think you could be eligible.
Seek out loan forgiveness for student loan debt
If you’re struggling with student loan repayments, you may be able to access financial aid to help you. Various programs offer student loan forgiveness, especially for graduates who work in the public sector or for nonprofit organizations.
Some student loan forgiveness programs include:
It’s also worth searching for programs related to your career.
What to do if you can’t lower your total loan cost
In a perfect world, you’d be able to take advantage of the advice outlined above to reduce your total loan cost. However, we don’t necessarily live in a perfect world. If none of the suggestions apply to you, fear not; you can still take action to keep on top of your debt.
Follow the debt avalanche method to focus on paying back the loans with the highest APR first, allowing you to tackle your debt as efficiently as possible.
If you’re still studying or recently graduated, make student loan payments while you’re within your grace period (meaning interest hasn’t started accruing) if possible. Resisting deferment now will help you out later down the line.
Above all else, try to make on-time payments to avoid penalties and other nasty consequences.
There’s a light at the end of the tunnel
Thinking about the total cost of your loan can get overwhelming, but there are many different options for reducing its value. So, pick whatever is relevant and possible for your situation, and start putting in the work.
We’ve mainly focused on installment loan debt here, but if you also need help with credit card debt, the Tally† can help. It can consolidate your higher-interest credit card debt into one lower-interest line of credit.
†To get the benefits of a Tally line of credit, you must qualify for and accept a Tally line of credit. The APR (which is the same as your interest rate) will be between 7.90% and 29.99% per year and will be based on your credit history. The APR will vary with the market based on the Prime Rate. Annual fees range from $0 - $300.