LoanMe’s customers sometimes ask about how principal and interest works for small business loans. It’s an important question. Many borrowers with longer term financing complain that principal isn’t being paid down fast enough.
This is true of most loans designed to span for 7 or more years. This includes:
• Credit cards
• Long term business or personal loans
To illustrate, let’s look at a LoanMe Small Business Loans, and compare the amortization to other long term lending products.
What is Amortization?
Amortization is the practice where the principal of a loan is paid down (amortized) over the life of the loan.
If you were to take out a home mortgage, most early payments go primarily toward interest. Over time, the percentage of your payment that represents principal gradually increases. The interest represented in each payment falls as principal paid rises over time.
In fact, let’s examine a 30-year fixed mortgage. Consider a $200,000 mortgage taken out at a 5% interest rate. Your payment for this mortgage would be $1,073.64 monthly.
An amortization table will show how much is still owed after each payment. More importantly, it will show that for the first several years, very little is paid down:
• $197,049.27 is owed after 1 year of payments
• $183,657.46 is owed after 5 years of payments
• $157,824.25 is owed after 10 years of payments
In fact, while your payment is fixed monthly at $1,073.64, your first mortgage payment will contain $833.33 in interest and $240.31 in principal, and if paid according to schedule, your 12th mortgage payment represents $822.09 going towards interest, and $251.56 going towards principal.
In the example above, after five years, you will have made $64,418.40 in payments. That $64,418.40 in payments, however, will only result in $16,342.54 in principal being paid down.
How Long Does it Take to Pay Down a Credit Card?
Some borrowers make only the minimum payments on credit cards. Imagine making only minimum payments on a $10,000 credit card with an interest rate of 15.49%
If the minimum payments were 1% of the balance, it would take 16 years to pay the card off. If you pay $100 more than the required minimum (as shown in the above example), your pay off time is reduced to 3 years! Virtually all experts recommend paying more than the minimum on your credit cards.
How Do LoanMe’s Loans Amortize?
Loans taken out with LoanMe amortize in the same way as any other loan. The amount of your payment that goes towards principal versus interest depends on:
• The length of your loan (loan term)
• The interest rate
Just like a mortgage or a credit card, when making only the minimum payment, almost all of your early payments go towards interest. For this reason, it is strongly recommended paying more than the minimum payment. You may make extra payments via check or ACH each month.
For example, let’s look at a term business loan for ten years. A higher-risk borrower may be offered a loan at an annual interest rate of 94%. Imagine a business owner, Mark. Mark takes out a $10,000 loan over 10 years at a 94% interest rate; his minimum payments would be $783.43 monthly.
If Mark paid $200 extra each month (paying $983.43 monthly, instead of the minimum of $783.43), his balance at the 12th month is $6,240.30, in comparison to $9,998.42 if only the minimum payment is made. If Mark continues to pay the additional $200 each month, instead of just making the minimum payment, he would pay off the loan in 21 months, and save over $72K in total financing costs.
Here’s how extra payments would impact Mark’s total loan term and costs:
Resource: Small Business Loan Calculator
As you can see, making more than the minimum payment can have an enormous impact on total cost funds and the payoff balance at the 12th month, if an additional payment is made each month.
Making more than the minimum payment can save considerable amounts of interest on your LoanMe loan and shorten your loan term considerably. We highly recommend paying more than your minimum payment for long term savings.
*This article has been prepared for general information purposes only. The information presented is not legal, financial, tax or accounting advice, is not to be acted on as such, and is subject to change without notice. Credit approval is subject to LoanMe’s credit standards, and actual terms (including actual loan amount) may vary by applicant. LoanMe requires certain supporting documentation with each new application. If you have any questions regarding this, call us at 844-311–2274. California loans are made pursuant to LoanMe’s California Department of Business Oversight Finance Lenders Law License #603K061. LoanMe also offers loans in certain other states which may have higher minimum loan amounts. Copyright © 2016 LoanMe, Inc. All rights reserved.