##### Posted by: meagher79

«**on:**May 28, 2020, 12:24:27 pm »

The key point is that the interest is charged each year regardless of the length of the loan. Let's take a very simple example using "simple interest" instead of compound interest. A $100 loan for one year at 10% interest would = $110 total repayment as you said, but a $100 loan at 10% interest for 5 years would = $150 because there is 10% interest each year.

The situation you describe with the 5 year loan does not reflect the circumstances because the borrower gets the full $100 at the beginning and gets to use the $100 for five years (less the amount repaid over time which does reduce the interest).

Maybe think of the 5 year loan as a series of one year loans. Suppose on Jan. 1 of 2010, I borrow $100 to buy an airplane part. On Jan. 1, 2011, I owe $110, but I'm not ready to repay, so I pay $10 interest, but I borrow another $100 to repay the first loan. The first loan is done, but on Jan 1, 2012 I owe $110 for the second loan. Again I get a new loan to repay the old one. Each year I have to pay $10 for the use of the $100 I continue to have borrowed. A five year loan just combines this process. (Actually it gets more complicated depending on the repayment schedule and compounding interest.)

Try playing around with a loan calculator such as this one: https://www.calculator.net/loan-calculator.html

You are using the first option: Amortized Loan, where the principle is paid off gradually over the life of the loan. As an example I looked at a $100,000 loan for 260 months in game. The total repayment was $124,100 (which the game calls 24.1% interest rate, actually its the total interest) I played around with the interest rate until I got the same total repayment and it was 8.85%

A very simple solution would be to just eliminate the shorter loans (they are a terrible deal compared to the 5yr), and change the "interest rate" label to "total interest percentage" as I suggested. The actual 5 yr loan rate seems pretty reasonable.

The situation you describe with the 5 year loan does not reflect the circumstances because the borrower gets the full $100 at the beginning and gets to use the $100 for five years (less the amount repaid over time which does reduce the interest).

Maybe think of the 5 year loan as a series of one year loans. Suppose on Jan. 1 of 2010, I borrow $100 to buy an airplane part. On Jan. 1, 2011, I owe $110, but I'm not ready to repay, so I pay $10 interest, but I borrow another $100 to repay the first loan. The first loan is done, but on Jan 1, 2012 I owe $110 for the second loan. Again I get a new loan to repay the old one. Each year I have to pay $10 for the use of the $100 I continue to have borrowed. A five year loan just combines this process. (Actually it gets more complicated depending on the repayment schedule and compounding interest.)

Try playing around with a loan calculator such as this one: https://www.calculator.net/loan-calculator.html

You are using the first option: Amortized Loan, where the principle is paid off gradually over the life of the loan. As an example I looked at a $100,000 loan for 260 months in game. The total repayment was $124,100 (which the game calls 24.1% interest rate, actually its the total interest) I played around with the interest rate until I got the same total repayment and it was 8.85%

A very simple solution would be to just eliminate the shorter loans (they are a terrible deal compared to the 5yr), and change the "interest rate" label to "total interest percentage" as I suggested. The actual 5 yr loan rate seems pretty reasonable.