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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Interest rates are usually advertised as annual rates.
So, if you borrow $100,000 you owe $5000 interest the first year. So if you pay $21,000 in the first year, you’ve paid the $5000 in interest and $16,000 in principal. Now you have $84,000 left to pay and the interest for the second year will be $4200. Every year the interest goes down, so you are paying more principal and less interest. Any extra payments you make go directly principal so interest goes down as well.
In reality it’s a bit more complex since interest is calculated more often, maybe daily but it works out almost the same.
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