Loan Repayment Methods Compared
Two loans with the same amount, rate and term can cost very different amounts of interest, depending on how the principal is paid back. This guide explains the four common methods, the formula behind the monthly payment and what to check before comparing offers.
Interest Is Charged on What You Still Owe
With most loans, each month's interest is the outstanding balance times the monthly rate. For a nominal annual rate, the monthly rate is the annual rate divided by 12: 6% a year means 0.5% a month. Each payment first covers that month's interest; whatever is left reduces the balance. The faster the balance falls, the less interest you pay in total.
The Four Methods
| Method | Monthly payment | Interest | Typical names |
|---|---|---|---|
| Equal payments (amortizing, annuity) | The same every month | On the falling balance; high at first, then lower | French amortization, 원리금균등, 元利均等, 等额本息, Tabela Price |
| Equal principal | Highest at first, then falling | On the falling balance; falls faster | Italian amortization, 원금균등, 元金均等, 等额本金, SAC |
| Interest-only, principal at the end | Interest only, then the whole principal | On the full amount for the whole term | Bullet loan, 만기일시, endfälliges Darlehen |
| Flat rate | The same every month | On the original amount, even after it is partly repaid | Add-on interest, bunga flat, ดอกเบี้ยคงที่ |
The Equal-Payment Formula
The level payment that repays a loan of P over n months at a monthly rate r is
payment = P × r ÷ (1 − (1 + r)−n)
For 200,000 at 5% a year over 30 years: r = 0.05 ÷ 12 = 0.0041667, n = 360, and the payment is 1,073.64 a month. Over 30 years that is 386,513 in total, of which 186,513 is interest. The same formula reproduces published examples: the US Consumer Financial Protection Bureau's sample Loan Estimate shows 761.78 a month for 162,000 at 3.875% over 30 years, and the calculator gives the same figure.
How Much Each Method Costs
For 100,000 at 6% a year repaid monthly over 10 years:
| Method | First payment | Last payment | Total interest |
|---|---|---|---|
| Equal payments | 1,110.21 | 1,109.34 | 33,224 |
| Equal principal | 1,333.33 | 837.90 | 30,250 |
| Interest-only | 500.00 | 100,500.00 | 60,000 |
| Flat rate 6% | 1,333.33 | 1,333.73 | 60,000 |
Equal principal costs the least because the balance falls fastest, at the price of the highest payments at the start. A flat rate of 6% costs as much interest as an interest-only loan, because interest is charged on the full amount throughout; the same payments on a falling balance correspond to a rate of about 10.2% a year. The calculator shows this "real" rate whenever you choose the flat-rate method.
Interest-Only Periods
Many loans start with months in which only interest is paid. The balance does not fall during that time, and the principal is then repaid over the remaining months, so later payments are higher and total interest grows. Enter the length of that period in the calculator to see its effect on the schedule.
Interest Rate, Effective Rate and APR
The nominal rate in a loan contract sets the interest; divided by 12, it is the monthly rate. Compounded monthly, a nominal 6% is an effective 6.17% a year. The annual percentage rate shown in loan advertisements is a different figure again. In the EU, the APR (APRC, TAEG, TAE, effektiver Jahreszins) is defined in the Consumer Credit Directive as an effective annual rate that also includes the cost of fees. Use the contract's nominal rate to work out the payment, and the APR to compare the full cost of offers.
Canadian fixed-rate mortgages are a special case. The Interest Act requires the rate to be stated "calculated yearly or half-yearly, not in advance", and fixed-rate mortgage agreements such as the sample below state the rate compounded twice a year, so the monthly rate is slightly less than the rate ÷ 12. The sample fixed-rate agreement of the Financial Consumer Agency of Canada (255,450 at 5.50% over 20 years) works out at 1,748.28 a month for principal and interest, which the calculator matches with the "compounded twice a year" option.
Why Your Lender's Figures May Differ
- Interest counted on the actual days in each month instead of twelve equal months.
- A first payment date more or less than a month after the loan starts.
- Fees, insurance or taxes added to the monthly payment.
- Different rounding of each payment, usually adjusted in the last one.
Frequently Asked Questions
Does paying extra early save interest?
Yes, because interest is charged on the balance. Any amount paid early stops earning interest for the lender from that month on. Check your contract for early repayment fees.
Why is most of my early payment interest?
With equal payments, interest is highest when the balance is highest. In the first month of the 200,000 example, 833.33 of the 1,073.64 payment is interest.
Which method should I choose?
If you can afford higher payments at the start, equal principal costs less interest. Equal payments are easier to budget. Avoid comparing a flat rate with a rate on the balance without converting it first.
Sources
Source: Interest Act (R.S.C., 1985, c. I-15), section 6; FCAC: sample credit agreement for a fixed-rate mortgage (archived) · Last checked:
Source: Directive (EU) 2023/2225 (consumer credit), Annex III · Last checked: