There are multiple types of loans, but the most common type is a self-terminating loan. These loans work by every time you make a payment you pay all of the interest that’s accumulated on loan as well as some of the principle. By the time the term of the loan has ended you have paid off the entire balance of the loan. The advantage of this type of loan is that you make equal payments, on the loan while paying off the balance of the loan.

Since the amount of interest is computed on the principle’s balance, as you make payments on the loan, the amount that you pay in interest is less. Meaning, that each time you make a payment you pay off more of the loan’s balance.

Take for example a 30 year $100,000 loan at a 6% interest rate. The amount you would pay, on the loan, would be $599.55 a month. During the first month, the loan accumulates $500 worth of interest. That leaves $99.55 which applied to the balance of the loan. During the second month, now that the loan’s balance is lower, only $499.50 worth of interest accumulates on the loan. So, when you make the $599.55 payment, $100.05 is applied to the balance of the loan.

Below is a graph showing the balance of the loan as time progresses.

Loan Balance.png

As the graph above shows, as time progresses, the rate at which the loan is decreasing increases as time progresses.