Total Cost of Borrowing: Components, Formula and Loan Cost Calculation

The total cost of borrowing means the total amount you owe to the lender, including all the additional charges and the interest rate. In simple terms, it is the total amount you will pay back to the lender. The borrower must know the total cost of borrowing from the lender if any sort of loan is taken. The total cost of borrowing must include factors like the interest rate and other charges (what you owe the lender). After taking the loan, you will not only repay the principal amount, but you also have to pay the total cost of borrowing to the lender. Moreover, the total cost of borrowing is a basic concept in finance, which has its own formula to calculate. 

Key takeaways: 

1. Total cost of borrowing is the total amount you will repay to the lender after taking the loan. 
2. The total cost of borrowing includes factors like taxes, interest rate, and other charges applied. 
3. The borrower should be aware of the total cost of borrowing before taking the loan from the lender. 

What are the components of the total cost of borrowing? 

The components of the total cost of borrowing include the interest rate and additional charges, taxes, insurance, etc. 

Here is the detailed explanation of the total cost of borrowing components: 

• Interest: it is the percentage you need to pay extra to the lender for borrowing their money.
• Fees: these fees include the processing charges, additional charges, etc.
• Taxes: GST will be applied to the processing fees and other servicing charges. GST is not applied to the principal amount.
• Insurance: Some lenders offer insurance against the loan to help to repay the outstanding amount due only under specific situations. This is not compulsory and is optional, provided for specific loan types only.

These are the main components of the total cost of borrowing, as you can count penalty charges, if applicable, document charges, processing charges, etc., into the additional charges.

How to calculate the total cost of borrowing on a flat interest rate? 

The formula for the total cost of borrowing in finance is simple and straightforward. You need to assimilate all the components of the total cost of borrowing to get the final answer. One thing the reader should understand is that the total cost of borrowing depends on the interest methodology, loan terms, applicable fees, and other charges. Therefore, no single universal formula applies to all loan types.

Here is the formula for the total cost of borrowing using the flat interest rate on a loan: 

Total cost of borrowing = Total EMIs + fees that are applied when taking a loan + taxes on services + other additional charges.

For example, you took a loan of ₹500,000 from Bank A at a flat interest rate of 10% per annum for 3 years. Moreover, you will pay a 2.5% processing fee and 1% in documentation charges, with 18% GST on services.

Therefore, your total cost of borrowing will be = 

1. Principal amount = ₹500,000
2. Interest rate = 10% = 10% of ₹500,000 = ₹50,000 x 3 years = ₹150,000
3. Total EMI Payments = (₹5,00,000) + (₹1,50,000) = ₹6,50,000
4. Processing fees = 2.5% = 2.5% of ₹500,000 = ₹12,500
5. Documentation charges = 1% = 1% of ₹500,000 = ₹5,000
6. GST = ₹12,500 + ₹5,000 = ₹17,500. So, 18% of ₹17,500 = ₹3,150

So, the repayment will be = ₹650,000 + ₹17,500 + ₹3,150 = ₹670,650.

Total borrowings = ₹670,650 – ₹500,000 = ₹170,650. 

If the fees and applicable taxes are deducted upfront from the loan amount, then

Net amount received = ₹500,000 – ₹12,500 – ₹5,000 – ₹3,150 = ₹479,350

Thus, in this example, we have taken the example of a flat interest rate. ₹650,000 is the principal with interest repayment; ₹170,650 is the total borrowing cost above the principal, and ₹479,350 is the net amount received after upfront deductions, assuming the stated charges.

Hence, the total cost of borrowing you have is ₹670,650. This is the amount you need to repay to the bank after 3 years. 

What factors can influence the total cost of borrowing? 

There are multiple factors that affect the total cost of borrowing. The impact of each factor depends on the lender's policies, loan type, and terms stated in the loan agreement. 

Here are the factors that impact the total cost of borrowing: 

• Repayment Tenure: Length of time agreed upon to clear the loan balance.
• Interest Calculation Methodology: The specific method used to compute interest charges.
• Applicable Fees and Service Charges: Mandatory processing and operational expenses tied to the loan.
• GST on Eligible Services: Applicable taxes levied on service fees and charges.

Hence, these are the factors that influence the total cost of borrowing. 

What are the advantages of the total cost of borrowing? 

There are several advantages of knowing the total cost of borrowing, especially when taking a loan. 

Here are the advantages: