How a loans repayment schedule is drawn up
In the repayment schedule, we can see a detailed breakdown of the interest rate we’ll pay and how the debt will evolve over time
The concept might sound rather technical, but really, the repayment schedule of our loan is nothing more than a table that shows how our debt evolves over time. In the financial sector, there are different ways to repay the money that a banking institution lends its customers, although in Spain the most common one is the straight-line method. No, we will go over what it involves and, above all, why it is important for you to know how a loan repayment schedule is drawn up.
How the repayment of a loan works
In any loan, there are three key factors that come into play: the capital lent, the interest rate it is lent at and the repayment period. These three variables, combined in one table, help us to draw up our repayment schedule, which sets out the composition of the installment payment month by month.
- Capital lent: this is the total sum of money we receive as customers.
- Interest rate: this is the price of obtaining that money. The interest rate can be fixed (it never changes) or variable (it varies based on a reference rate, which is usually the Euribor).
- Repayment period: the length of time we have to repay the loan, divided into monthly installments.
As we have explained, in Spain a loan repayment schedule is usually calculated based on the straight-line method, which involves the customer always paying the same monthly installment throughout the term of the loan. Of course, this depends on the interest rate that is chosen – fixed or variable rate – and the possible conditions under which the loan is contracted; for example, some banks offer loans that have a lower monthly installment payment during the first few years of the loan.
In any case, that monthly installment will always be made up of two elements: the capital we have been lent and which we are repaying, and the interest charges we pay for that money. Therefore, using the repayment schedule we can see how that debt evolves month by month with the payment of the installments, and check that the interest charges we pay for the capital we have requested get smaller and smaller every month in the installments we pay, in proportion to what we have left to pay of the loan.
On this point it is worth highlighting that the cost of a loan is greater, the longer it takes us to repay that money since interest charges are paid for a longer amount of time. But let’s look at everything more clearly with the following example.
Repayment schedule example
For the following example, we are going to simplify as much as possible all the possibilities available when requesting a loan. Let’s imagine we need €20,000 for a new vehicle and we go to our trusted banking institution to get it. There they tell us that the interest rate of the loan is a 7% annual fixed rate and they offer us to repay it over 10 years. Therefore, our repayment schedule shows the following data:
- Total of the installment payments: 120.
- Monthly installment: €232.22.
- The composition of the first installment:
- Capital that we are repaying: €115.55.
- Interest: €116.67.
- The composition of installment number 60 (halfway through the term of the loan):
- Capital that we are repaying: €162.86.
- Interest: €69.36.
- The composition of installment number 120 (last installment):
- Capital that we are repaying: €230.29.
- Interest: €1.34.
With these numbers, we can see how the composition of our monthly installment has changed over time. We have gone from paying 50.24% in interest in the first installment to paying 29.8% in installment number 60. By the end of the repayment period, the interest we pay represents barely 0.5% of the total of the monthly installment. In other words, we pay practically no interest at all.
Broadly speaking, that is how the repayment schedule of a loan works. It shows us that the larger the amount of the loan and the longer the repayment period, the higher the proportion of interest we pay in each monthly installment. It is, therefore, a very useful tool for knowing what we are paying at any given time and for weighing up different options when taking out a loan.
Last, of all, it is worth adding that BBVA offers you a loan simulator so that you can use it to find out, in detail, what the repayment schedule for your loan is.