How banks calculate interest – and what it means for your loan repayments

Banks only charge interest on the precise amount of money outstanding on your loan. They calculate this interest every day.

To show how this works, here’s a simplified example:

• On Friday you borrow $100k.
• Over the weekend, your long-lost granny re-connects with you. She wants to give you $10k.
• On Monday you walk into the bank and deposit that $10k, and ask the bank to use it to pay down part of the loan.
• On Tuesday your loan is now $90k and your daily loan interest charged is reduced accordingly.
  

This may affect the way you pay down your loan.

People often ask us if they should save up a lump sum, then use that ‘lump’ to pay down their loan.

The idea is sound, but you shouldn’t wait until you’ve got a big lump. Small, regular payments can chip away at the principal and reduce the total amount outstanding. 

Remember, interest is calculated daily. It’s better to be reducing your loan steadily rather than waiting a year to make a really big dent in it – no matter how satisfying that may feel.

There’s an important caveat, which is that some types of loan don’t allow you to chip away at the principal every month. So it’s important to get specific advice that relates to your financial situation and goals. 

But in general, you’ll be better off if you continuously reduce the total amount you owe interest on (i.e. the principal). So you can look at hacks like keeping your payments at the same level when interest rates drop. It could end up shaving years off your loan.

Get personalised advice.

If you’d like to review the structure of your loan and get some advice on being smart with interest, we’re here to talk. A good time to talk is when it’s time for your loan to rollover, or when your financial situation has changed.

Just book a chat using the buttons below.