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Financial Learning Center


Introduction

Total Cost of Borrowing

This chart shows the total cost of borrowing $20,000 at various interest rates and repayment periods.

Interest Rate

5-Year Loan

10-Year Loan

15-Year Loan

30-Year Loan

3% $21,540 $23,160 $24,840 $30,240
4% $22,080 $24,240 $26,640 $34,200
5% $22,620 $25,440 $28,440 $38,520
6% $23,220 $26,640 $30,420 $43,200
7% $23,760 $27,840 $32,400 $47,880

As you can see, borrowing can be costly, especially if you take out a long-term loan. It is important to look at other alternatives to borrowing before making a final decision.

Before you borrow, you should compare the after-tax interest rate you are earning on your assets to the after-tax interest rate you will have to pay to borrow money. For example, suppose you have the $20,000 you need in a savings account earning 1% interest. After paying taxes on your interest (e.g., at a rate of 25%), you are really earning an after-tax rate of 0.75%. Unless you can borrow money at an after-tax rate below 0.75%, you'd be better off using the money in your savings account (unless it is your emergency fund). See the following illustration of how this after-tax interest rate is arrived at.

a) Current Interest Rate

1.0%

b) Marginal Tax Rate

25.0%

c) Multiply (a) times (b)

.25%

d) After-Tax Rate of Return
Subtract: (a) minus (c)


.75%

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