Principal Repayment

Most loan payments are made up of two parts: interest, which is the cost of borrowing, and principal, which pays down the debt itself. Only the principal portion reduces the amount you owe.

With a typical repayment loan, payments stay the same each month, but the split changes over time. Early on, when the balance is high, most of each payment goes towards interest. As the balance falls, less interest is due, so more of each payment goes towards principal.

For example, on a loan of 10,000 at 6% a year, repaid monthly over three years, each payment is about 304. In the first month, about 50 goes to interest and about 254 reduces the balance. By the final months, almost all of each payment goes towards principal.

Making extra principal repayments, where the loan allows it, reduces the balance faster and cuts the total interest paid. Some loans charge fees for early repayment, so it is worth checking the terms. With interest-only loans, regular payments cover only the interest, and the principal must be repaid separately.