How loan repayment works
Almost every consumer loan — personal, auto, student, home — is an amortising loan. You pay the same amount every month, and each payment is split between interest on the balance you still owe and principal that reduces that balance.
Because the balance falls each month, the interest charged falls too, so a growing share of each fixed payment goes to principal. The payment never changes; its composition changes constantly.
The loan payment formula
- M
- Monthly payment
- P
- Principal — the amount borrowed
- r
- Monthly rate — annual rate ÷ 12 ÷ 100
- n
- Number of monthly payments
Solving in the other direction — how long a given payment takes to clear a balance — uses logarithms:
This is what the "Find the term" mode above computes. If your payment is smaller than the first month's interest, the expression is undefined, because the balance would grow rather than shrink.
A worked example
Total repaid $31,503 — of which $6,503 is interest, about 26% of the amount borrowed.
Interest rate is not the same as APR
The interest rate is what you are charged on the balance. The APR folds in origination fees and other mandatory costs, expressed as an annualised rate. APR is the number to compare offers on, because a lower rate with a 5% origination fee can cost more than a higher rate with none.
A $25,000 loan at 9.5% with a 3% origination fee has an APR closer to 10.9%. Enter the fee in the advanced options above to see the effect on total cost.
| Loan type | Excellent credit | Fair credit |
|---|---|---|
| Auto loan (new) | 5% – 7% | 11% – 15% |
| Personal loan | 7% – 12% | 18% – 30% |
| Home equity | 7% – 9% | 10% – 13% |
| Credit card | 18% – 22% | 25% – 30% |
| Student loan (private) | 5% – 9% | 12% – 15% |
Frequently asked questions
How do I lower my monthly loan payment?
Three levers: borrow less, extend the term, or get a lower rate. Extending the term reduces the payment but raises total interest — the same $25,000 over 7 years instead of 5 drops the payment to about $409 but adds roughly $2,900 of interest.
Refinancing to a lower rate is the only option that reduces both the payment and the total cost, which is why it is worth checking whenever your credit score improves.
Does paying extra each month actually help?
Substantially, because every extra dollar goes straight to principal and removes all the future interest that dollar would have accrued. On a $25,000 5-year loan at 9.5%, paying $100 extra a month clears it 11 months early and saves about $1,200.
Confirm with your lender that extra payments are applied to principal rather than held as a prepaid future instalment.
What is the difference between secured and unsecured loans?
A secured loan is backed by an asset the lender can seize — a house for a mortgage, a car for an auto loan. Because the lender has recourse, rates are lower.
An unsecured loan, such as most personal loans and credit cards, is backed only by your promise to repay. Rates are higher to compensate for the risk, typically by 5 to 15 percentage points.
Will applying for a loan hurt my credit score?
A single hard enquiry typically costs fewer than 5 points and recovers within months. Rate-shopping for the same loan type within a 14 to 45 day window is usually counted as one enquiry by scoring models.
Many lenders offer pre-qualification using a soft enquiry, which does not affect your score at all. Use that to narrow the field before formally applying.
Should I take a longer term for a lower payment?
Only if the shorter-term payment genuinely does not fit your budget. A longer term always costs more in total, and on a depreciating asset like a car it raises the risk of owing more than the asset is worth.
If cash flow is tight, a longer term with the intention of paying extra is a reasonable middle path — you get the lower required payment as a safety net while paying it down faster in practice.