How loan repayments work, and how to pay less interest

Home loans, car loans and most personal loans are amortising loans: you pay the same amount every period, and each repayment covers that period's interest first, with the rest reducing what you owe. Because interest is charged on the balance, early repayments are mostly interest and later ones are mostly principal.

How the repayment is calculated

Repayment = P × i ÷ (1 − (1 + i)⁻ⁿ)

where P is the amount borrowed, i is the interest rate per repayment period (the annual rate divided by 12 for monthly repayments) and n is the total number of repayments.

A home loan example

Borrow $300,000 at 6% over 30 years with monthly repayments. Each repayment is $1,798.65. Over the full term you'd repay about $647,500, so the interest comes to roughly $347,500, more than the amount borrowed.

In the very first month, interest is $300,000 × 0.5% = $1,500, so only about $299 of your repayment reduces the loan. That balance shifts slowly in your favour every month.

Three ways to pay less interest

1. Pay a little extra

Adding just $200 a month to the loan above pays it off in about 23 years 3 months instead of 30, and saves about $91,000 in interest. Every extra dollar goes straight to reducing the balance, so it stops being charged interest for the rest of the loan.

2. Pay half the monthly amount every fortnight

There are 26 fortnights in a year, so paying half your monthly repayment every fortnight adds up to 13 monthly repayments a year instead of 12. On the same loan, paying $899.33 a fortnight clears it in about 24½ years and saves around $74,000 in interest.

3. Compare the comparison rate

Lenders' fees can make a low headline rate more expensive than it looks. In Australia, lenders must also show a comparison rate that builds in most fees, which makes offers easier to compare fairly.

Shorter loans cost less overall

A shorter term means higher repayments but much less interest. A $30,000 car loan at 8% over 5 years costs $608.29 a month and about $6,500 in interest in total. Stretching the same loan to 7 years lowers the repayment but adds noticeably more interest.

This guide is general information only, not financial advice. Check exact figures, fees and any penalties for extra repayments with your lender.

Try it: the loan repayment calculator does this instantly, free and in your browser.