It is always a good idea to do your homework before you make a major purchase or enter into a financial transaction, and private student loans should be no exception. The more you understand about the cost of borrowing—before you borrow—the better. The concept of a loan is pretty straightforward: first you borrow money, and then you repay it.
But the amount that you must repay is more than the amount you borrow. This is due to interest and fees, which is what a lender charges you for the use of its money. It is also referred to as a finance charge.
A finance charge is the dollar amount that the loan will cost you. Lenders generally charge what is known as simple interest. The formula to calculate simple interest is: principal x rate x time = interest (with time being the number of days borrowed divided by the number of days in a year).
Consider the following: If you borrow a $2,500 loan with an interest rate of 5% for a period of one year, the interest you owe will be $125 ($2,500 x .05 x 1). This means you would repay a total of $2,625 ($2,500 + $125). The table below illustrates how a loan payment is applied first to the accrued interest owed, then
toward your current principal balance, assuming a 24-month payment plan.
The Cost of Borrowing
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