Repayment

Repayment is the process of paying back money that has been borrowed, together with any interest and fees, to the lender. The amount originally borrowed is called the principal. The loan agreement sets out how and when the borrower must repay: the size of each instalment, the dates, the method of payment and what happens if a payment is missed.

Repayment applies to every kind of debt, from a personal loan or mortgage to a credit card, a corporate bank facility or a government bond. The structure chosen, whether steady instalments, interest-only payments or a single lump sum at the end, shapes how much interest the borrower pays in total and how much risk the lender carries.

Borrowing is like renting money. The principal is the thing you rented, and interest is the rent. Repayment is giving it all back, plus the rent you owe for the time you had it.

You can give it back in different ways. You can pay a little every month until nothing is left, like paying off a sofa in instalments. You can pay only the rent each month and return the whole amount at the end. Or you can hand everything back in one go on an agreed date. The more slowly you give back the principal, the longer you pay rent on it, so the total cost rises.

• Amortising repayment. Each instalment covers that period's interest plus part of the principal, so the balance falls to zero by the end of the term. Most mortgages, car loans and personal loans work this way. When instalments are equal, early payments are mostly interest and later payments mostly principal.
• Interest-only repayment. The borrower pays just the interest during the term and repays the whole principal at the end, often from a sale, savings or refinancing. Some mortgages and buy-to-let loans use this structure.
• Bullet repayment. Little or nothing is paid until maturity, when the full principal falls due. Most bonds pay regular coupons and then repay principal in a single bullet. A loan with smaller instalments and a large final payment is said to carry a balloon payment.
• Revolving repayment. On a credit card or overdraft, the borrower can repay and borrow again within a limit, subject to a minimum monthly payment.

Retail lenders also offer short instalment plans such as buy now, pay later (BNPL), which split a purchase into a few equal payments.

For an amortising loan with equal instalments, the payment per period is:

• $P$ is the instalment paid each period.
• $L$ is the loan principal.
• $r$ is the interest rate per period, written as a decimal (an annual rate divided by 12 for monthly payments).
• $n$ is the total number of payments.

Worked example: a borrower takes 10,000 at 12% a year, repaid monthly over one year. The monthly rate is $r = 0.12 \div 12 = 0.01$ and $n = 12$. Then $(1.01)^{-12} \approx 0.8874$, so the denominator is $1 - 0.8874 = 0.1126$, and $P \approx 100 \div 0.1126 \approx 888.49$.

In month one, interest is $10{,}000 \times 0.01 = 100$, so 788.49 of the first payment reduces principal, leaving 9,211.51. Over twelve payments the borrower pays about 10,661.85, of which about 661.85 is interest. Writing each month's split in a table produces the loan's amortisation schedule. Because interest is charged on the falling balance, the cost is lower than simple interest on the full amount for the full year; the annual percentage rate (APR) lets borrowers compare loans that include fees.

Instalments are usually collected by Direct Debit or paid by standing order from the borrower's account on a fixed date. Many lenders let borrowers make overpayments or repay early to save interest, but some charge an early-repayment fee, especially on fixed-rate loans, to recover the interest they expected to earn.

A missed or late payment is reported to a credit bureau and can lower the borrower's credit score, as well as triggering late fees and extra interest. If arrears continue, a secured lender may enforce its rights over the collateral. Banks classify loans that stop being repaid, commonly after 90 days overdue, as a non-performing loan (NPL) and must set money aside against the expected loss. When a country stops repaying its creditors, the event is a sovereign default.

Borrowers in difficulty can often agree a payment holiday, a longer term or a reduced plan with the lender, and free debt management advice is available in many countries.

Because Islamic law prohibits riba (interest), Islamic banks structure financing so that repayments are payments of a sale price or rent rather than interest. Under murabaha, the customer repays the bank's cost plus an agreed profit in instalments; under ijarah, the customer pays rent and may gradually buy the asset. The repayment schedule can look much like a conventional loan, but the contract and the risks are different.

• Financial Conduct Authority