What Is Interest Due?
Interest due represents the dollar amount required to pay the interest cost of a loan for the payment period. When a borrower takes out a loan from a bank, the loan must be paid back in monthly payments or installments until the debt is satisfied.
However, financial institutions charge borrowers an added cost for lending money, which is the interest due to the bank. Interest due is based on the interest rate that's applied to the total outstanding loan balance.
Depending on the type of loan or credit product, the payment structure for the loan might vary slightly. Typically, each payment covers the interest charged on the loan for the period, the interest due, and reduces the original amount owed, called the principal balance.
- Interest due represents the dollar amount required to pay the interest cost of a loan for the payment period.
- Financial institutions charge borrowers an added cost for lending money, which is the interest due to the bank.
- Interest due is based on the interest rate that's applied to the total outstanding loan balance.
- Typically, each monthly payment has a portion allocated to pay down the principal balance and a portion allocated to the interest due for that month.
How Interest Due Works
Interest due is a component of the total loan payment based on the interest rate and the total amount that was initially borrowed. The higher the interest rate, the more interest will be due on a monthly basis. Similarly, the higher the loan balance, the more interest will be due versus a smaller loan with the same interest rate.
The total interest due over the life alone is important for borrowers to consider before going through with the loan. If, for example, a $30,000 dollars loan was taken out to purchase a car and at the end of the loan, the customer paid $40,000, the extra $10,000 would be the total interest charged for the loan.
Typically, the total interest due by the end of the loan is broken up into monthly installments. Each payment has an amount allocated to pay a portion of the principal balance owed and an amount allocated to cover the interest due for that month.
Interest Due for Loan Payments
Many loans such as mortgages, personal loans, and auto loans have similar payment structures in which a portion of each payment pays interest, and a portion goes to principal. This schedule of loan payments is called an amortization schedule.
The interest due each month is calculated based on the most recent balance of the loan. Banks typically front-load the interest so that they get paid most of the interest in the early years. This practice ensures that the bank earns its profit from the loan sooner rather than later. By requiring more interest to be paid earlier on, also reduces the risk of the bank not getting paid all of the interest due in the event the borrower defaults or goes into nonpayment.
As a result, earlier in the payment schedule, a greater share of the monthly payment goes to interest due, while a smaller portion goes to pay down the principal balance. As time goes on, the allocation to principal and interest reverses, meaning the interest due for each payment decreases, while a greater share of the payment goes to the principal balance.
This inverse relationship between interest due and principal due occurs, in part, because loan payments are typically a fixed amount. Also, as the loan balance decreases, the monthly interest owed decreases since the interest rate is now based on a smaller loan amount. As the interest owed decreases, the principal portion increases since it represents a larger share of the fixed monthly payment.
Interest Due for Credit Cards
Credit card interest works differently than with fixed-rate loans. Credit cards offer a revolving credit line in which a consumer or business can borrow up to a certain limit. Once the customer pays down the balance owed on the credit card, they can borrow up to that limit again. Typically, the minimum monthly payment for a credit card goes primarily to the interest due. A borrower would need to pay above the minimum payment amount in order to pay down the principal amount owed.
Credit card interest rates are calculated based on an annual percentage rate (APR), which is a variable interest rate based on a benchmark such as the prime rate. For example, a credit card company might charge a rate of 15% above the prime rate, so if the prime rate is 6%, the rate on the card would be 21% per year.
Although it's an annual rate, the interest is calculated daily based on the balance on the card. If a borrower pays off the balance every month before the due date, they could conceivably not be charged any interest. It's important that customers read the fine print to understand how interest is charged because it can vary between credit card companies.
Some companies compound the interest, meaning if interest is added to the unpaid balance, interest accrues on the interest that was added to the balance. In other words, you're paying interest on interest, which is how credit card debt can quickly spiral out of control.
Example of Interest Due
Let's say that a customer opened a 30 year fixed rate mortgage loan for a balance of $300,000 at a 5% annual interest rate. The first payment is due in June of 2021. Insurance and taxes have been excluded for illustrative purposes.
Below is a portion of the amortization schedule using the Investopedia amortization calculator. The table shows the split between interest due and the principal balance at various June payment dates throughout the 30-year period.
- For the first payment in June 2021, $360.46 will go to reducing the principal balance while $1,250.00 towards interest due for the month.
- By June 2030, $564.79 will go towards the principal and $1,045.67 towards paying the interest due for that month.
- By June 2040, more money will go towards the principal than interest, with $930.22 reducing the principal and $680.25 towards the interest.
- By June 2050, $1,532.08 will go towards the principal balance while only $78.38 towards the interest due for the month.
|Example of Interest Due with a 30-year Fixed Rate Mortgage|