Below is an example of how interest and principal payments work. It is essential to know, so you realize that even putting an extra $10 per week or month can make a big difference.

This example shows a loan of $360,000 at an interest rate of 6% p.a. over a 30 year term. The monthly payment is $2,158.38. From payment one interest is $1,800 and $358.38 is coming off the principal (loan amount), therefore the balance of the loan after one payment is $359,641.62.

Where most people get confused is thinking their payment will go down if they place extra funds on their loan. The payments will stay the same (unless interest rates change) it is the structure of the payment which changes, which is the most important.

Now if you place extra funds on your loan, the payment stays the same however the interest is a less amount and principal is a higher amount, meaning you pay your loan off quicker, and/or have funds available in redraw.

As you can see from the table below, every month the interest is a bit less and the principal (amount coming off the loan) is a little bit more. This is of course because the loan amount is slowly decreasing (getting smaller).

Most lenders work out the interest daily, and then at the end of the month add it up and place it on the loan which then gets paid via your monthly payment. Therefore, any extra money you put on your loan comes directly off the principal (loan amount) and reduces the interest immediately. This is also how your 100% offset account works with most lenders. Daily, they look at your loan amount subtract whatever the balance of your offset account is and then work out the interest for the day. This is why the longer you have the funds in your offset account or on your loan the more interest is saves you.

Loan Amount: | $360,000.00** | Interest Rate: | 6.00 %** |

Extra Payments Per Month: | $0.00** | Loan Term: | 30 years** |

Monthly Payment: $2,158.38

Year |
Payment Number |
Interest (this payment) |
Principal (this payment) |
Interest (to date) |
Principal (to date) |
Principal Remaining |

1 | 1 | $1,800.00 | $358.38 | $1,800.00 | $358.38 | $359,641.62 |

2 | $1,798.21 | $360.17 | $3,598.21 | $718.55 | $359,281.45 | |

3 | $1,796.41 | $361.97 | $5,394.62 | $1,080.52 | $358,919.48 | |

4 | $1,794.60 | $363.78 | $7,189.21 | $1,444.31 | $358,555.69 | |

5 | $1,792.78 | $365.60 | $8,981.99 | $1,809.91 | $358,190.09 | |

6 | $1,790.95 | $367.43 | $10,772.94 | $2,177.34 | $357,822.66 | |

7 | $1,789.11 | $369.27 | $12,562.05 | $2,546.61 | $357,453.39 | |

8 | $1,787.27 | $371.11 | $14,349.32 | $2,917.72 | $357,082.28 | |

9 | $1,785.41 | $372.97 | $16,134.73 | $3,290.69 | $356,709.31 | |

10 | $1,783.55 | $374.83 | $17,918.28 | $3,665.52 | $356,334.48 | |

11 | $1,781.67 | $376.71 | $19,699.95 | $4,042.23 | $355,957.77 | |

12 | $1,779.79 | $378.59 | $21,479.74 | $4,420.82 | $355,579.18 | |

2 | 13 | $1,777.90 | $380.48 | $23,257.64 | $4,801.30 | $355,198.70 |

You have a sum of $10,000 for a short period, and you go and look at term deposits. The best term deposit you can find for 3 months is 4.95% p.a. – you think this is really good. So you put you $10,000 in for 3 months, you obtain a return of approx. $124.00, which you also have to declare on your tax. Let’s say the above was you home loan; if you would have put you $10,000 on your home loan for 3 month it means not only are you saving 6% tax free on your $10,000 but it also decreases the interest on interest amount. Let’s have a look how that would have worked:

Monthly Payment: $2,158.38

Loan amount $360,000

Year |
Payment Number |
Interest (this payment) |
Principal (this payment) |
Interest (to date) |
Principal (to date) |
Principal Remaining |

1 | 1 | $1,800.00 | $358.38 | $1,800.00 | $358.38 | $359,641.62 |

$10,000 | 2 | $1,748.21 | $410.17 | $3,548.21 | $768.55 | $348,887.07 |

3 | $1,744.43 | $413.97 | $5,292.64 | $1,182.52 | $348,473.10 | |

$10,000 | 4 | $1,742.37 | $416.01 | $7,035.01 | $1,598.53 | $358,057.09 |

*Approximate amounts as example only*

Therefore, the difference between the top tables of payments, just making the minimum payments without the extra $10,000 was $358,555.69 and in the above table after the 3 months the total is $358,057.09 which is a saving of $498.60 tax free.