Say there’s a loan for $10,000. The interest rate is 11%. Monthly payment is $300.
How can you keep interest at bay, and not pay thousands in interest by the end of it all?
Is there a formula to figure out how much *extra* to pay per month, in order to… cancel out? the interest?
Is this even possible? Is this even how interest works?
Honestly, I don’t get the concept at all. Explain it to me like I’m five.
In: Economics
$300 is how much you **have** to pay. That doesn’t mean you can’t pay more. So pay an extra $100 or $300 every month.
You never cancel out 100% of the interest unless you pay the full 10k off right away.
Just pay the loan faster than the term is for. That’s how you save on interest. The faster you pay it, the less interest the borrower pays.
As long as the loan still exists, it is always accruing interest. Each month you are paying off all the interest that you currently owe, plus some of the remaining balance of the loan. By the time your next payment is due, additional interest has accumulated based on the remaining balance of the loan. The more you pay each month, the less loan is left, so the less interest builds up during the next month. But as long as the loan exists, it’ll always accrue interest. That’s the fee the bank charges you for still having their money. The faster you pay the loan down, the less interest builds up since it’s a percentage of the remaining balance.
With your example numbers, the interest charged to the loan the first month is about $91.
That means the bank puts $91 in their pocket and takes $209 off your loan balance.
The second month, because your $10k is now $209 less, the interest is only $89.75 which means $210.25 comes off the balance.
And so on and so forth, the balance gets lower, the interest gets lower, the principal loan balance is paid off.
If you make extra repayment, say $100. That entire $100 comes off the loan balance. Now the second month interest is $88.83. That’s a small difference at the start, but it gets magnified over the life of the loan.
There’s a calculator that can show you the difference here: https://www.gatewaybank.com.au/about-us/calculators/extra-repayment-calculator/
The only way to functionally cancel out interest is to pay off the entirety of the loan right away, in which case, why are you even taking out a loan in the first place?
How much of your payment goes to interest depends on how your interest is compounded and the terms of your loan. I would recommend referring to the TILA (Truth In Lending Act) form that typically accompanies these loans. It should lay out the general structure of your loan, including what would go to the interest.
Long story short, the greater the amount you pay each month, the more goes to the principle and the less you would have to pay in interest otherwise.
You can’t cancel out the interest unless you pay the whole loan off at the first payment. However the more money you pay toward the principal the less money goes to interest every month.
I’ll let someone else math this out for you because I’m not able to right this second, but basically the more you pay toward the principal on top of your regular payment the less interest you are paying because it’s calculated monthly based on the principal left.
If you pay double payments, you’ll get paid off in less than half the time, because you’re cutting your interest so drastically. You pay interest all the way up to the last payment. The last payment is probably only $2 in interest, and the first payment is probably closer to $90 going toward interest… So the faster you paid on the principal the less interest you pay over the entire course of the loan. That’s the best you can do.
$10,000 x (11%/100) = $1,100
That’s how much you have to pay per year to cover just the interest so the amount owed doesn’t increase.
($1,100 / 12 = $91.66 per month)
**Simple, eli5 math would work like this:**
The interest payment does not go to principle, so you’re going to pay $300 a month *just to keep the loan going forever.*
To pay down the *loan*, you need to pay principle. How much you should pay depends on a) what you can afford, and b) how quickly you want to pay it down.
To figure out how to calculate that, it’s simple. Take the $10K and divide by how much extra you can pay, then add the $300 interest on top of that. You will pay down the loan by the amount you’re paying extra every month.
Using your example: Say you want to pay off the loan in a year:
**$10K / 12 months = $834 per month.**
**$834 (principle) + $300 (interest) = $1134.**
**So, if you pay $1134 per month, you will pay off the $10K debt in 12 months.**
This makes a bunch of assumptions (like you don’t add to the debt) and I’m hand-waving over interest rates. But that’s the general idea.
Make sense?
Everyone here explained the mathematics regarding loans and interest but I feel like the true reality isn’t being spoken.
Whether you’re really well paid or just scraping by, paying off a loan sooner requires sacrifice of excess amenities. It sucks and it’s hard but if you don’t want to be stuck in a seemingly endless loop of payments for many years, you have to pay with everything you can spare.
The only reason to pay just the minimum is circumstantial on a month-to-month basis like using that excess cash you spared to make investments(starting a business, learning classes for better job prospects, etc.) that will outpace your loan interest or for emergency spendings. You should always try to pay higher than the minimum if the goal is to relieve yourself from the loan.
Also do not believe what they state is your minimum. Some times they quote that as just barely above the cost of interest and a bit of the principal. The true minimum is what you can afford to pay monthly consistently that is also above the cost of yearly interest and what they stated as your minimum.
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