Money, Explained From the Inside

Tools / Borrow / Chapter 11 · The True Cost of Borrowing

True cost of a loan

The monthly payment is what lenders show you. The cost of credit is what you pay. Enter the offer exactly as quoted, including any flat rate or fees.

1 · The idea

Level payment (reducing balance)

Each month you owe interest on what is left, and the payment is set so the balance reaches exactly zero after n payments. A flat rate instead charges interest on the full amount for the whole term: Payment = (P + P × rate × years) ÷ n.

The formula

Payment = P × r ÷ (1 − (1 + r)^−n)

P
amount borrowed
r
monthly rate (annual rate ÷ 12)
n
number of monthly payments
Cost of credit
total repaid − amount borrowed + fees

2 · A worked example

$10,000 at 6% flat over 24 months: payment = (10,000 + 10,000 × 6% × 2) ÷ 24 = $466.67. Interest is $1,200. But because you are repaying the balance down, this is equivalent to 11.1% on a reducing balance.

3 · Now use your own numbers

Change anything. The result updates instantly.

Try an example

Reducing: interest is charged on what you still owe. Flat: on the original amount, always. If unsure, ask the lender; it matters a great deal.

Monthly payment
$387.50
Total cost of credit
$3,900Interest plus fees
Total you repay
$18,600
Effective annual rate (with fees)
12.7%Quoted: 6.00% flat
Same loan as a reducing-balance rate
11.0%Before fees. The number to compare with other offers.
05k10k15k20k081624324048
Months on the horizontal axis.
  • What you actually still owe
  • What flat interest is charged on

What this means

A flat rate charges interest on the full amount for the whole term, even though you are repaying it month by month. That is why “6% flat” behaves like a loan at roughly twice that rate.

Fees paid up front lift the effective rate because you receive less than you owe. Compare offers on total cost of credit and effective rate, not on the payment.

Illustrative, not personal advice. Inspired by Chapter 11 · The True Cost of Borrowing of Money, Explained From the Inside. Your figures stay in this browser. Real products add terms, taxes and conditions that this simple model leaves out.

4 · Take care

What this tool can’t see

  • Some lenders add insurance or “processing” charges not shown in the rate. Add every upfront charge to Fees.
  • A longer term lowers the payment but raises the total cost.

5 · Go further

Where this fits

See it in a life:

DavidIncome without wealth

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