If I borrow 100k at 5% interest, and to be paid back in 5 years, why is it not that case that I just pay 21k per year and would have paid 105k after 5 years? I heard that if I pay back a little extra every year, it will help to go pay off the interest first, what does that mean? If I owe a set amount of money on fixed interest, how can the total amount change?
In: 4
The interest is compounded monthly.
So you have a $100k loan at 5%, after the first month it compounds, meaning 100k + (100k * (.05/12)). This means after 1 months you owe $100,416.66. obviously you worked out terms of a minimum monthly payment. And it needs to be more than $416.66 for you to ever pay off the loan. So let’s say you pay $21k/year. That’s $1750/month. So after your first payment you owe $98,666.66. at the end of the second month it compounds again, so $98,666.66(1+(0.05/12)) so you owe $99,077.71. which means $411.11 is generated in interest. As you pay down the principal the amount of interest generated gets smaller. Because it’s just a % of the principal. In your case, at 5% apr, compounded monthly, you add .04% each month.
The reason making extra payments early is important is that the principal is larger, so the amount of interest generated is larger.
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