Loans are complex financial products that are designed to provide the borrower the required funds and at the same time deliver the lender a level of profit commensurate with their risk. The profit to the lender is driven by the amount borrowed, the interest rate and the duration of the loan.
So for a customer borrowing money we always like to look for the benefits of making additional payments. We start the process by looking at an amortisation schedule. This is a calculator that takes the key inputs of loan amount, interest rate, duration of the loan and start date. For example, a loan of $150,000 at 6.0% interest, over 25 years would result in monthly payments of $966.45 per month. That equates to interest of $139, 935.63 over the life of the loan. That’s the lender’s return for lending the money.
By paying a small amount extra each month the borrower can take advantage of the financial mathematics sitting behind an amortisation schedule. For example, if the borrower in the above example paid say $20 per week extra taking the monthly repayments to $1,046.45 per month, then the loan is paid off 3.9 years quicker and reduces the total interest to $114,632.45 over the life of the loan. This would save $25 303.18 in interest payments that you would not have to make!
That’s because the additional payments are made to the balance of the loan which is the base upon which the interest is calculated. The balance in this case is the initial $150,000
So the cumulative effect of small changes can have a massive impact over the life of the loan. This impact can result in real savings in total amount paid and make you closer to being debt free. The challenge is seeing the long term benefit and being disciplined enough to stick to a well thought out game plan.
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