How does repaying a loan actually work?

We will provide a clear example that illustrates how different variables affect the repayment structure of the loan:

Let's compare two borrowers: Both borrowers took out a loan for $100,000 at 7% interest, fully amortized. However Borrower A took a 3-year term, while Borrower B took a 5-year term:

For both borrowers, a $100,000 amortized loan at 7% interest means that the loan payments will be spread out over a fixed period of time and that each payment will include both principal (the amount borrowed) and interest (the cost of borrowing the money).

For Borrower A with a 3-year term, the repayment structure will be as follows:

• The loan will be divided into 36 equal monthly payments.
• Each payment will include both principal and interest.
• The amount of each payment will be $3,092.04.
• At the end of 3 years, the borrower will have paid a total of $111,313.44 ($3,092.04 x 36).

For Borrower B with a 5-year term, the repayment structure will be as follows:

• The loan will be divided into 60 equal monthly payments.
• Each payment will include both principal and interest.
• The amount of each payment will be $1,996.67.
• At the end of 5 years, the borrower will have paid a total of $119,800.20 ($1,996.67 x 60).

The difference in the total payback amount is $8,486.76 ($119,800.20 - $111,313.44). This means that Borrower B with the 5-year term will end up paying more in interest over the life of the loan because they are borrowing the money for a longer period of time.

Borrower A has a shorter term, so they have to make larger monthly payments to pay off the loan within three years. On the other hand, Borrower B has a longer term, so they can make smaller monthly payments, but they end up paying more interest over the five-year term.

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