Financial Answer Center
- People Aren't Saving Enough
- Racking Up Debt
- What You Will Learn in this Section
- Should I Borrow Money?
- Total Cost of Borrowing
- Think Before You Borrow–Key Considerations
- Where Should I Borrow?
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 |
|
