When it comes time to take out a loan, you will need to consider many factors. The loan may be for a new car or for a home remodeling project. No matter what it is for, you will need to consider the interest rate and any possible prepayment penalties that come with the loan. While it may seem daunting at first to think about these specialized terms – after all, you’re busy planning to build a new deck – they are easier to understand if you think about one pro and con of each.
Higher Interest Rates
Pro: It’s Quick and Easy
The facilitation of higher interest rate loans usually happens quickly since there is not an extensive background check. Think of the higher interest rate as a form of payment for this convenience. In the same way that a convenience store charges for an expedited shopping experience, a higher interest rate loan will charge for its quick and easy process. On the plus side, you will quickly have the needed funds in your hands.
Con: Repay More Money Later
When you need money quickly – think of a hard money loan – the tradeoff is that you may need to pay more back later. This is an individual decision. With any loan, interest will be a factor. You will need to consider how much interest you could afford and factor in the entire cost of the loan – including the interest. If receiving the money quickly without an extensive credit check is advantageous then the higher interest rate will be something that you will need to accept.
Lower Prepayment Penalties
Pro: Saves Money on the Long Run
When you prepay on your loan, you will save money in the long run, since you will be sidestepping the added interest on the credit. By prepaying, you are literally cutting the loan’s lifespan down. With a lower prepayment penalty, you will not be as taxed for this prepayment but the penalty is still a factor. In addition, a lower prepayment penalty will help you build equity on the loan at a faster rate than over the full life of the loan.
Con: It Still Seems Like “Punishment”
Even if the prepayment penalty is lower than usual, this is not something you will be able to ignore. Therefore, you may feel that you have a sense that you are being “punished” by doing something good. After all, you’re doing something good by repaying the loan early, right? The answer here is yes and no. You have to understand that the lender is also a business – one that needs to make a profit. Therefore, by prepaying your loan, you are somehow short-circuiting this profit hence the penalty.
Understanding and comparing higher interest rates vs. lower prepayment penalties is not such a difficult task. The key is to be able to separate these two important terms along a pro and con on each side. After doing so, you will be able to better see which path you should take while obtaining your much needed credit.