How Loan Payments Are Calculated
When you take out a loan, your lender calculates a fixed monthly payment that covers both interest and principal, structured so the loan is fully repaid by the end of the term. This structure is called amortisation.
The Monthly Payment Formula
M = P × [r(1+r)ⁿ] ÷ [(1+r)ⁿ − 1]
P = principal (loan amount)
r = monthly interest rate (annual rate ÷ 12)
n = total number of payments (years × 12)Example: £10,000 at 6% APR over 3 years
r = 0.06 ÷ 12 = 0.005
n = 36
M = 10,000 × [0.005 × 1.005³⁶] ÷ [1.005³⁶ − 1] = £304.22/month
Total repaid: £10,951.92 | Total interest: £951.92How Amortisation Works
Early payments are mostly interest; later payments are mostly principal. On the loan above, payment 1 is ~£50 interest + ~£254 principal; payment 36 is ~£1.52 interest + ~£302.70 principal. This is why early repayments have the biggest impact on reducing total interest.
Key Variables That Change Your Payment
- Higher interest rate: Higher monthly payment and much more total interest
- Longer term: Lower monthly payment but far more total interest paid
- Larger principal: Proportionally higher payment and interest
Flat Rate vs Reducing Balance
A flat rate loan charges interest on the original principal throughout — a 10% flat rate is closer to 18% effective. A reducing balance loan charges interest only on the outstanding balance, which is standard in most Western markets and significantly cheaper. Always compare the APR (Annual Percentage Rate), not the headline rate.
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