Regular Payments: How a Loan Shrinks and Savings Grow

0:00You borrow $20,000 at 6% a year, and repay 60 monthly payments of $386.66. Where does each one go?

0:11Compounded monthly means interest is charged each month: 6% divided by 12, or 0.5%.

0:21A common mistake is thinking the whole payment comes off the balance, the amount you still owe.

0:27Interest is paid first: in month 1, 0.5% of $20,000 is $100.

0:36Only the rest, $286.66, pays off principal, the money you borrowed.

0:43So you still owe $19,713.34: $100 more than the mistake says.

0:52Each month the balance is smaller, so less interest is charged and more comes off.

0:58This table, each payment split into interest and principal, is called an amortization schedule.

1:05Over the 60 payments, interest shrinks and principal grows. In the last one, under $2 is interest.

1:14Altogether the 60 payments come to $23,199.60, so about $3,200 is interest.

1:25A 25-year mortgage works the same way: at 6%, about 78% of its first payment is interest.

1:33Savings work the other way: deposit $200 at the end of each month, at the same rate.

1:40In month 2, the $200 earns $1, and the next $200 makes $401.

1:48Then interest earns interest too. This is compound interest, so growth speeds up.

1:55After 10 years, $24,000 of deposits grows to $32,775.87, the future value. The difference is interest.

2:08Recap: each month, interest is worked out on the balance, so a loan shrinks slowly at first and savings grow faster over time.