Have you ever found yourself in a situation where you were struggling to understand key terms like principal, amortization, and interest when dealing with a lender? Most of the time people just skim through these terms and simply ask how much they need to pay and for how long. Understanding these concepts can help you gain financial advantage, pay less in interest, and get ahead in your life. Here are some key terms that will help you better understand loans:
Principal: The principal is the original amount of money you borrowed. For example, if you took
out a student loan for $10,000, that’s your principal.
Interest: Interest is the extra money you have to pay in addition to the principal. It’s like a fee
for borrowing the money. The interest rate is a percentage that determines how much extra
you’ll pay. So, if you have a 5% interest rate on a $10,000 loan, you’ll need to pay back $10,500
in total.
Payments on Principal: When you make a loan payment, a portion of it goes toward paying off
the principal, reducing the amount you borrowed. The other part of the payment goes towards
the interest.
Amortization: Amortization is the process of spreading out your loan payments over a set
period, usually in monthly installments, and gradually paying off debt. These payments are calculated in a way that you pay off both the principal and interest over time.
Here is an example to help you understand how it works:
Let’s say you borrowed $5,000 for your education, and the interest rate is 4%. Your loan term is
5 years, meaning you have 5 years to pay it back.
Each month, you’ll make a payment that includes a part of the $5,000 principal and a portion of
the 4% interest. In the beginning, more of your payment will go towards interest, and as time goes on, a larger portion will go towards the principal. The graph below from our Cash Course tool shows how each payment goes both towards principal and interest annually over time.
Depending on the length of your loan, interest, which accumulates over time,
might end up being a significant portion of your repayment. It is the primary reason for the exponential growth of student loans and why it is so hard to get out of debt. As you make regular payments, the loan balance decreases, and by the end of the 5-year period, you’ll have fully paid off both the principal and the interest.
Using this example, helps us see how paying off a debt early can save hundreds or thousands of dollars over time.
It is important to note that this is a simplified explanation how loans and interests work.
In order to be able to calculate exactly how much you will need to pay for a certain loan and
specific interest, visit Cashcourse.com where every Emory student is able to create a free
account and perform various sophisticated calculations.
Also, it’s important to make your payments on time and in full because failing to do so could lead to
penalties, extra fees, and can negatively impact your credit score. Remember, when you take
out a loan, it’s essential to understand the terms, interest rate, and repayment plan. Being
responsible with your loans will help you manage your finances better and build a strong
financial future.