Each repayment has two jobs: A repayment usually covers interest first, then reduces the principal still owed.
| Part of repayment | Purpose |
|---|---|
| Interest part | cost of borrowing |
| Principal part | reduces the loan balance |
The loan balance falls over time: As the balance falls, the interest part usually becomes smaller.
Concept example
A monthly repayment is $400. If $120 is interest, how much reduces the principal?
Step by step
- Principal reduction = repayment - interest.
Final answer
$280 reduces the principal.
Do not call the whole payment interest: Only part of the repayment is interest. The rest actually pays off the loan.
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Amortization: Amortization means gradually reducing a loan through regular repayments until the balance reaches zero.
| Early in loan | Later in loan |
|---|---|
| Higher balance, so often more interest | Lower balance, so often less interest |
| Smaller share paying off principal | Larger share paying off principal |
Read the table language: IB may give repayment tables, balance schedules, or plain-language descriptions. The structure idea is the same.
Interpretation example
Why might the same monthly repayment clear more principal later in the loan?
Step by step
- Because the outstanding balance is smaller later on.
- That usually means less interest is charged in that period.
Final answer
More of the repayment can go toward principal later in the loan.
This is a pattern question: You do not always need a full amortization table. Sometimes IB just wants you to explain the pattern.