Three kinds of loans
- Monthly payments (amortized): mortgages, car loans, personal and student loans. You pay the same amount each month until the balance is zero.
- One payment at the end (deferred): some business loans and private notes. Nothing is paid until maturity, so interest compounds on itself and you repay principal plus all interest at once.
- Bond or fixed amount at maturity: zero-coupon bonds and discounted notes. You know what's due at the end, and the calculator works out what it's worth today.
Why compounding frequency matters
For deferred loans and bonds, interest can compound yearly, monthly, daily or continuously. More frequent compounding means slightly more interest at the same stated rate. The results show the effective annual rate so you can compare loans fairly.
Example
Monthly payments: $100,000 at 6% for 10 years is $1,110.21 a month. Deferred: the same $100,000 at 6% compounded monthly, repaid in one payment after 10 years, grows to $181,939.67.
Frequently asked questions
What's the difference between APR and interest rate?
The interest rate is the cost of borrowing the principal. APR adds certain fees and expresses the total as a yearly rate, so it's usually a bit higher. Compare APRs when shopping for loans.
Which loan type costs the most interest?
At the same rate and term, a deferred loan costs the most, because no principal is repaid along the way and interest compounds on interest.