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What is Loan Interest?

What is Loan Interest?

Interest is an additional percentage of a loan payment that is added to the principal of a loan paid every month to the lending agency (oftentimes, a bank) in exchange for holding the loan. The interest on a loan, once the loan is paid in full, is in addition to the principal amount the borrower requested and was approved for when the loan’s term began. Usually, for a loan term, the interest is described in terms of the annual percentage rate (APR).

By way of illustration, let’s say Shawna has saved up for a continuing education course in her profession. However, her savings doesn’t cover all of the supplies she needs to complete the course. She takes out a loan with a principal amount of $325 to cover the cost of materials for the course. Over time, her loan amount will include both the principal ($325) and an interest rate percentage. Her payments will go towards both the principal and the interest until she is able to pay it in full. The total amount she will pay on the loan will be higher than the initial $325 principal from the beginning of the loan due to the interest.

Another example would be Jana. She takes out a loan for a used car and interest is expressed in terms of a rate of 5% APR, meaning any time she makes a payment on her loan, she pays a portion of it towards the principal (the original loan amount) and a portion towards the interest. If her loan is $5000 and her term is 5 years, her payment is about $95. About $74 of her payment goes towards the principal, but the other portion of it – $21 – is what she pays towards interest on the loan.

Financial Terms and Definitions