Why Is My Loan Balance Still So High After Years Of Payments?

You are not alone in asking this question. So many people take out a loan for school, a car, or anything else and find themselves checking the balance down the road only to notice it is much higher than they anticipated. If you took out a $20,000 5 year car loan it would make sense that in 2.5 years of making your payments on time that the loan balance would be 10,000, but that is not the case.

The reason that this is not the case is because of the interest being charged on the outstanding balance of the money that you borrowed. When you take out a loan for $20,000 you are not paying back $20,000, depending on your interest rate but as long as it is over 0.0% you are paying back more than the $20,000 over that time as the fee for borrowing that money. So for example if you have a car loan for that 20k at 8% interest for 5 years, you will be paying a total of $24,331.67 over the course of the 5 years and the default would be to make equal payments of $405.53 each month for 60 months. 

As you make these payments of $405.53 your loan balance drop with each payment, but it will not drop by the full payment amount, it will only drop by the amount of the payment that is allocated to principal after you have paid off the interest for that period. As your loan matures and your loan balance decreases a larger and larger portion of that $405.53 payment will be allocated to the principal or balance paydown as the interest on the outstanding balance decreases. For example, the first payment you make on this loan will be $405.53 but because you still have an outstanding balance on the loan of $20,000 your interest for this month is 20,000*8%/12 months = $133.34. So that means that of your first payment the first $133.34 goes towards the interest and does not pay down the outstanding $20,000 and then the remaining 272.19 will go towards the paydown of the balance. So after your first payment your new loan balance will be $19727.80. Now lets say you are entering your last year and are on your 49th payment and continue to pay the $405.53 every month your loan balance would now be $4661.86 so this month's payment would be $31.08 towards interest and $374.45 towards the principal paydown. 

Because a larger portion of your payment is having to be used to pay off the interest at the beginning of a loan when the loan balance is higher, you see less reduction in the loan balance towards the beginning of the loan payoff timeframe and much more towards the end when the balance is accruing less interest each period. 

When approaching a loan or planning to pay down loans, you can always calculate your total cost of the payoff by using the payoff period and interest rate on the balance of the loan. If you want to reduce your total cost of the loan you can pay off the loan early by making larger or more frequent than required payments. If you do decide to contribute more to your loan payoff make sure that you payment or additional payment is applied to the principal of the loan rather than the future interest to ensure that you are reducing the total cost of the loan and the balance. If you have questions be sure to talk to a professional as all loans are different and have different rules around payoffs. 

Hopefully this gives you a better understanding of the true costs of borrowing money and allows you to take control and understand your situation to give you what you need to live a value driven life.