How loan and mortgage interest works (and how to pay less)

Most personal loans, car loans and mortgages are amortizing loans: you pay the same amount every month, and each payment covers the interest that has accrued on what you still owe, plus a slice of the capital. Because the balance falls, the interest part shrinks month after month and the capital part grows, even though the payment itself never changes.

The quickest route here: enter your amount, rate and term in the Loan calculator to see the payment, the total interest and the month-by-month breakdown. Everything below explains where those numbers come from.

The monthly payment

For a fixed-rate loan the payment is:

M = P × r ÷ (1 − (1 + r)^−n)

where P is the amount borrowed, r the monthly rate (annual rate ÷ 12) and n the number of monthly payments.

Borrow 15,000 at 6.5% over 5 years: r = 0.065 ÷ 12 = 0.0054167 and n = 60, which gives a payment of 293.49. Over the 60 months you repay 17,609.53 in total, so the interest is 2,609.53 — about 17.4% of the amount borrowed.

What an amortization table shows

An amortization table lists, for every payment, how much goes to interest, how much goes to capital, and what is left to repay. For the loan above:

Payment	Interest	Capital	Balance after
1	81.25	212.24	14,787.76
2	80.10	213.39	14,574.37
12	68.26	225.24	12,375.83
30	45.25	248.24	8,106.40
60	1.58	291.91	0.00

Each interest figure is simply the balance multiplied by the monthly rate: 15,000 × 0.0054167 = 81.25 for the first month. Everything else in the payment reduces the balance.

Why early payments are mostly interest

Interest is charged on the remaining balance, and at the start the balance is at its highest. In the example above, 27.7% of the first payment is interest and only 0.5% of the last one is. Over the first year you pay 897.74 of interest and repay 2,624.17 of capital; over the fifth year, 120.93 of interest and 3,400.98 of capital.

The effect is far stronger on long loans. On a 240,000 mortgage at 3.8% over 25 years the payment is 1,240.46, and the first month splits into 760.00 of interest and 480.46 of capital. After five full years you have paid 42,734.47 in interest and reduced the debt by only 31,692.88.

This is also why selling or refinancing early feels expensive: you have paid a lot of interest but own little of the capital.

Term length: lower payment, higher total cost

Stretching a loan lowers the monthly payment and raises the total interest, because you owe more for longer. On that 240,000 mortgage at 3.8%:

Term	Monthly payment	Total interest	Total repaid
20 years	1,429.18	103,004	343,004
25 years	1,240.46	132,137	372,137
30 years	1,118.30	162,587	402,587

Going from 20 to 30 years cuts the payment by 311 a month and adds 59,583 of interest. Try your own figures in the Mortgage calculator.

The rate matters at least as much as the term: the same 25-year loan at 4.8% instead of 3.8% costs 1,375.19 a month and 172,558 in interest — 40,421 more for one extra point.

Extra repayments

Any amount you repay beyond the scheduled payment goes straight to the capital, so it stops producing interest for the whole remaining life of the loan. On the 25-year example:

What you add	Loan cleared in	Interest paid	Saved
Nothing	25 years	132,137	—
100 a month	22 years 1 month	114,844	17,293
200 a month	19 years 10 months	101,679	30,458
One extra payment a year	22 years 1 month	115,080	17,057

Two things to check before you commit: whether your lender charges an early-repayment fee, and whether the extra money shortens the term or reduces the payment — those are different products and only the first produces the savings above.

Nominal rate versus APR (TAEG)

The nominal rate only covers interest. The APR — annual percentage rate, TAEG in France — folds in the mandatory costs of the credit: arrangement fees, compulsory insurance, account charges. It is the figure to compare between offers.

Take the 15,000 loan again, with a 300 arrangement fee deducted at the start. The payment stays at 293.49, but you actually receive 14,700. The rate that makes those 60 payments equivalent to 14,700 is 0.6123% a month — 7.35% if you annualise by multiplying by twelve, or 7.60% if you compound it. Either way, well above the 6.5% on the offer.

Conventions differ between markets: the European TAEG is an effective annual rate, while a US APR is usually the periodic rate multiplied by the number of periods. Compare APRs quoted under the same convention, and check what each lender has included.

Insurance can dominate the difference. Adding a loan insurance premium of 0.25% of the borrowed capital per year to that 25-year mortgage costs 50.00 a month, 15,000 over the full term, and takes the all-in rate from 3.8% to roughly 4.18% on the same multiply-by-twelve basis.

Questions people ask

Is this the same as compound interest? The mechanics are related — interest accrues on a balance — but on an amortizing loan you pay the interest as it arises, so it never joins the capital. When you save, unpaid interest does join the capital: see Compound interest and the guide How compound interest works.

What about simple interest? Some short-term and consumer credit is quoted as simple interest on the original amount, which is not the same thing at all. The Simple interest calculator shows that version.

Why does my bank's figure differ by a few euros? Lenders round payments, may charge interest on an actual-days basis rather than in equal twelfths, and sometimes add fees to the first instalment.

Does a variable rate change the table? Yes. Every rate change produces a new payment or a new term, so the amortization table is recalculated from the current balance.

Is 17.4% of the amount borrowed a lot of interest? It is what 6.5% over five years produces; the guide How to calculate percentages explains why a rate and a total cost are not the same number.

Next steps

• Payment and schedule for a consumer loan: Loan calculator
• Property purchase: Mortgage calculator
• The same mathematics working for you: Compound interest

These calculators give estimates for planning, based on a fixed rate and equal monthly payments. Your lender's contract and its amortization schedule are the figures that count. This guide is not financial advice.