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Understanding how loans work

It is useful to understand how loan repayments work.

Repayments can be calculated as factors. These factors are based on the monthly payment required per $1,000 of debt.

Factors for loans with interest rates from 6.5% to 9% over 5 year to 30 year terms

loans-repayment2

For example, if you had a loan of $100,000 at 7% and paid it back at   $899   a month, the loan would be paid off in 15 years (100 x 8.99).

The factors illustrate the way compound interest works. Notice that relatively small increases in repayments will reduce the loan from 30 years to 20 years, but it takes a large increase in repayments to decrease the loan from 10 to 5 years.

As the term of the loan lengthens, the effect of the interest rate resulting in the amount of interest you pay increases exponentially. Paying a loan back at $20 per $1,000 borrowed will pay the loan off in 5 years. Interest rates have very little effect. Paying less than $8 per month increases the loan term to over 20 years. Now interest rates start playing a major factor in the amount of interest that has to be repaid.

Paying your loan back at $12 per $1,000 a month, if possible, will reduce the term to approximately 10 years and take interest rates out of the equation as the term of the loan will be largely unaffected by rate fluctuations.

If you can’t do $12 per $1,000 try to pay back at least $8 per $1,000. As you can see from the above table this will keep your loan to around 20 years.