How Loan Interest Works: APR, Amortization and Total Cost

Updated November 2026

This guide is general information, not financial advice. Loan terms, fees and rules vary by lender and country, so always check the figures in your own loan agreement.

The interest rate is the number every loan advert leads with, but it is only part of what a loan costs. Fees, the length of the loan and the way it is repaid can change the total by thousands. This guide walks through the mechanics with one worked example, so you can check any offer yourself with the Loan Calculator.

Interest rate vs APR

The interest rate (or nominal rate) is the yearly percentage charged on the money you owe. The APR, or annual percentage rate, adds most compulsory costs of borrowing, such as arrangement or origination fees, and expresses the total as one yearly rate. Many countries require lenders to show an APR or a similar figure so that offers can be compared fairly.

An example shows why it matters. You borrow 10,000 over 3 years at 7%, and a 300 fee is deducted from the money paid out. The monthly payment is 308.77 and the interest totals 1,115.75, but you only receive 9,700, so the loan really costs you 1,415.75. Expressed as a yearly rate, that is an APR of about 9.07%. A competing loan at 7.5% with no fee costs 1,198.24 in interest, which is less, even though its headline rate is higher.

Two more details:

• APR assumes you keep the loan to the end. If you repay early, an upfront fee weighs even more heavily.
• Rates charged monthly compound slightly within the year. A 6% yearly rate charged monthly is 0.5% a month, which works out at an effective 6.17% a year. Small daily rates add up too: 0.05% a day is 18.25% a year before any compounding.

How amortization works

Most personal loans, car loans and mortgages are amortizing: you pay the same amount every month, and each payment first covers that month’s interest, while the rest reduces the balance (the principal). Interest is charged only on what you still owe, so as the balance shrinks, more of each payment goes to principal.

Take a loan of 20,000 at 6% a year over 5 years. The monthly rate is 6% ÷ 12 = 0.5%, and the monthly payment works out at 386.66. In the first month, interest is 20,000 × 0.5% = 100.00, so 286.66 goes to principal and the balance falls to 19,713.34. In the second month, interest is charged on that lower balance: 19,713.34 × 0.5% = 98.57.

The last payment is slightly smaller because each month’s interest is rounded to the cent. Grouped by year, the shift from interest to principal is easy to see:

Total interest comes to 3,199.35. In the first year almost a quarter of what you pay is interest; in the last year it is about 3%. If the same loan were repaid with equal principal payments instead (333.33 of principal plus that month’s interest), the first payment would be 433.33, the last 335.00, and total interest 3,050.00. The Loan Calculator handles both methods; just switch the repayment type.

How the loan term changes the total

A longer term lowers the monthly payment, but you pay interest for longer. The same 20,000 at 6%:

Stretching the loan from 5 to 7 years lowers the payment by 94.49 a month but adds 1,343.02 in interest. In practice, longer terms often carry higher rates as well, which widens the gap. A sensible approach is the shortest term whose payment you can comfortably afford, while still leaving room for emergencies.

What extra payments do

Money paid on top of the regular payment normally goes straight to principal (check that your lender applies it that way), so less interest builds up from then on. For the same 5-year loan:

A one-off payment works too: adding 2,000 to the 12th payment ends the loan after 54 months and saves 506.17 in interest. The earlier extra money goes in, the more it saves, because it removes principal that would otherwise collect interest for longer.

Before overpaying, check three things: whether there is an early repayment fee, whether the lender shortens the term or lowers the payment (shortening the term saves more), and whether the money would do more good elsewhere, for example in an emergency fund or paying off a higher-rate debt first.

Simple vs compound interest

With simple interest, interest is calculated only on the original amount. With compound interest, interest is added to the balance and then earns interest itself. For 10,000 at 5% a year:

On an amortizing loan paid on time, interest does not compound: each month’s interest is paid in full, so it never joins the balance. Compounding works against you when interest goes unpaid, as with a credit card balance you do not clear or a loan whose unpaid interest is added to the balance during a payment break. A card charging 24% a year at 2% a month has an effective rate of about 26.8% if the balance is left to grow. On savings, the same effect works for you; the Compound Interest Calculator shows it year by year.

The rule of 72

To estimate how many years it takes for an amount to double, divide 72 by the yearly rate:

The rule is closest for rates of roughly 6–10% and drifts at the extremes, but it is good enough for a quick check. It applies to debt as well as savings: an unpaid balance growing at 2% a month doubles in about 35 months. It works for inflation too: at 3% a year, prices double in about 24 years. For other quick sums, such as what share of a payment is interest, the Percentage Calculator helps.

Before you sign

• Ask for the APR and the total amount repayable, not just the monthly payment.
• Check whether the rate is fixed or variable, and how a variable rate is set.
• Look for fees: arrangement, early repayment, late payment and required insurance.
• Run the numbers yourself, trying a shorter term and a small extra monthly payment.
• Confirm that extra payments are allowed and how they are applied.

Related tools

• Loan Calculator – monthly payment, total interest and a full repayment schedule.
• Compound Interest Calculator – how savings grow with interest and monthly deposits.
• Percentage Calculator – percentages, percentage change and more.