How Loan Payments Work
Car loans, mortgages, student loans: they all work the same way. Learn what you're really paying for, and how a little extra each month can save thousands.
Principal and interest
The principal is the amount you borrow. Interest is what the lender charges for it, as a yearly percentage of what you still owe.
The term is how long you have to repay: a car loan might be 5 years, a mortgage 30.
APR: the number to compare
The APR (annual percentage rate) includes the interest rate plus most fees, as a yearly rate. When comparing two loans, compare APRs, not just the monthly payment.
Longer terms look cheaper. Stretching a loan from 3 to 6 years lowers the monthly payment, but you pay interest for twice as long, so the total cost goes up.
Where each payment goes
Most loans have a fixed monthly payment. Each payment first covers that month's interest; the rest reduces the principal. This schedule is called amortisation.
Early on you owe more, so more of each payment is interest. As the balance shrinks, more of each payment goes to the principal.
Paying extra saves money
Anything extra you pay goes straight to the principal, which cuts the interest on every future month. Check your loan has no early-repayment penalty first.
Estimates for a standard fixed-rate loan. Your lender's figures may differ slightly. Not financial advice.