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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>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?
That’s 5% interest per year not for the entire life of the loan
I think that this misunderstanding is the core of your questions.
When you let a mortgage just sit there (or any loan really) it will keep accruing interest over time.
It’s not a one and done flat fee for taking out the loan like you describe. With that in mind I’ll still answer some of your other questions.
>Why does a portion goes to interest and another to principle?
So that’s because of something called amortization. This means taking a loan and making it so that you pay the same amount of money every month on it .At the beginning of the loan you have a large outstanding loan that’s accruing interest.
(I’m mostly to slightly simplify the math here, btw but the concepts are all the same) With a 100k loan with 5% interest like you describe that means in the first year you will accrue 5k in interest. Now lets say your fixed payment is $900 a month
That’s about $400 a month in interest so for your early payments we be “paying off” about $400 a month in interest and the leftover amount, in this case $500, goes toward the principal. But let’s fast forward to when you only have 10k left on that loan. Now your interest is only about $40 a month. So $860 goes towards the principles.
>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?
Simple, you spent less time with a large amount of money accruing interest. Let’s take a really extreme example. For that 100k loan after one year you might pay $5k interest that first year, and then about 4.9k in the second year, etc all the way to you paying a total of about 190k over 30 years
Or you can just pay off all the money immediately and pay zero interest at all.
>If I owe a set amount of money on fixed interest, how can the total amount change?
This goes back to that initial misunderstanding. Interest builds over time, it’s not a flat fee.
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