Every fixed-rate loan payment you make is split between interest (cost of borrowing) and principal (reduction of the original balance). In the early months of a loan, the majority of each payment goes toward interest. As the balance falls, each payment covers less interest and more principal — this is amortisation. Understanding this structure helps you evaluate loans, plan early repayments, and compare total borrowing costs.
Amortisation Formula
Monthly Payment (EMI) = P × [r(1+r)ⁿ] ÷ [(1+r)ⁿ − 1]
Where: P = principal loan amount, r = monthly interest rate (annual rate ÷ 12), n = total number of monthly payments.
Example: £10,000 loan at 6% annual interest over 3 years (36 months). Monthly rate r = 0.06/12 = 0.005. EMI = 10,000 × [0.005 × (1.005)³⁶] ÷ [(1.005)³⁶ − 1] = £304.22/month. Total repaid = £10,951.92. Total interest = £951.92.
Impact of Loan Term on Total Cost
| Loan Amount | Rate | Term | Monthly EMI | Total Interest |
|---|---|---|---|---|
| $10,000 | 6% | 1 year | $860.66 | $327.92 |
| $10,000 | 6% | 3 years | $304.22 | $951.92 |
| $10,000 | 6% | 5 years | $193.33 | $1,599.68 |
A shorter term means higher monthly payments but dramatically lower total interest. A longer term is easier on monthly cash flow but costs more overall. Use this calculator to find the balance that works for your budget.
Early Repayment and Overpayments
Making overpayments — paying more than your minimum EMI each month — reduces your outstanding principal faster, which reduces the interest charged in every subsequent period. Even small consistent overpayments (£50–£100/month on a £10,000 loan) can cut months off your loan term and save hundreds in interest. Check your loan agreement for early repayment charges before making lump-sum overpayments.