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?
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Mortgages use compound interest meaning in part that they charge interest on the amount owing on the loan, not the original amount.
Since your monthly payment is fixed this works out to you paying a greater percentage of interest and less principal at the start of the loan.
If you borrow $100,000 at 5% you’ll pay $5000 in interest in the first year
If your payment is $1000 a month, that’s $12000 of payments, or $7000 in principal paid off on the loan.
The following year you owe $93000 so you pay $4650 in interest and so on
The further along you are in the loan, the more principal you pay. So if you can over pay on your mortgage at the beginning and reduce your principal, it will greatly reduce how much you pay in interest in the long term.
(That’s not exactly how it works, interest is calculated by the payment not the year but you get the idea)
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