How Loans Work
Short answer
A loan is renting someone else’s money. You take an amount now and return more — with interest. The higher the rate and the longer the term — the more you’ll overpay.
Calculate it yourself
Enter the amount, rate, and term — see how much you’ll really pay:
| Year | Principal | Interest | Balance |
|---|---|---|---|
| 1 | $16,540 | $35,110 | $283,460 |
| 2 | $18,637 | $33,012 | $264,823 |
| 3 | $21,001 | $30,649 | $243,822 |
| 4 | $23,664 | $27,985 | $220,158 |
| 5 | $26,666 | $24,984 | $193,492 |
| 6 | $30,047 | $21,602 | $163,445 |
| 7 | $33,858 | $17,791 | $129,587 |
| 8 | $38,152 | $13,497 | $91,434 |
| 9 | $42,991 | $8,659 | $48,443 |
| 10 | $48,443 | $3,206 | $0 |
Annuity payment — same amount each month. At the start, most of the payment goes to interest; by the end — to principal.
How payments work
The most common type is an annuity payment: you pay the same amount every month. But inside that amount, the proportions change:
At the start — nearly the entire payment goes to interest. The principal decreases slowly.
By the end — nearly the entire payment goes to principal. Almost no interest left.
This means: if you pay off the loan early at the beginning, you’ll save the most. At the end of the term, early repayment saves almost nothing — the interest has already been paid.
The interest rate isn’t what it seems
The bank says “6% annual” — sounds manageable. But on a 30-year mortgage you’ll overpay more than you borrowed.
| Amount | Rate | Term | Overpayment |
|---|---|---|---|
| $300,000 | 6% | 15 years | ~$156,000 (52%) |
| $300,000 | 6% | 30 years | ~$347,000 (116%) |
| $300,000 | 3% | 30 years | ~$155,000 (52%) |
The difference between 15 and 30 years at 6% is an extra $191,000. And the difference between 6% and 3% at the same term is even more dramatic.
The true cost of a loan
The interest rate isn’t the only expense. Watch out for:
- Insurance. Often mandatory. Can add 0.5–1.5% annually.
- Fees. Origination fees, account maintenance, processing.
- Add-on products. Job loss protection, extended warranties.
Lenders are required to disclose the APR (Annual Percentage Rate) — it’s always higher than the advertised rate. Look at that number.
When a loan makes sense
- Mortgage. Housing appreciates, rent goes up too. At a reasonable rate, buying can beat renting.
- Education. An investment in income that can outpace the overpayment.
- Business. If the profit exceeds the interest rate.
When a loan is dangerous
- Consumer loans for wants. A $1,000 phone on a 20% loan — in 2 years it’s worth $300, but you’ve paid $1,250.
- Credit cards. The grace period is convenient, but rates after it: 20–30% APR.
- Loans to cover loans. A debt spiral.
Remember
A loan is not “free money” — it’s a rental with a markup. Before taking one, calculate the total amount you’ll return. If the overpayment shocks you — that’s the real price of the loan.