How Loan Interest Really Works
Understand APR, amortization and why early payments are mostly interest, with tips to pay less.
When you borrow money you pay back the amount borrowed (the principal) plus interest, the price of borrowing. Understanding how that interest is charged can save you thousands.
Interest rate vs APR
The interest rate is the basic cost of borrowing. APR includes certain fees too, so it shows a more complete cost. When you compare lenders, compare APR to APR.
What is amortization?
Most loans use amortization: you pay the same amount each month, but the split changes. At the start, most of your payment covers interest. As the balance falls, more goes to principal. That is why paying extra early on makes such a difference.
Term length changes the cost
A longer term lowers the monthly payment but increases the total interest. For example, a $25,000 loan at 7.5% costs about $5,057 in interest over 5 years, but around $8,300 over 8 years. You can test your own numbers in the loan payment calculator, which also shows a yearly schedule.
Ways to pay less interest
- Improve your credit score before applying.
- Choose the shortest term you can comfortably afford.
- Make extra payments and tell the lender to apply them to principal.
- Compare at least three offers.
- Check for early repayment fees.
Planning something specific? Try the car loan calculator or the mortgage calculator.