What is reducing balance interest?
Reducing balance interest is calculated on the outstanding principal rather than the original loan amount. As payments reduce principal, the interest charged in later periods normally falls.
How the calculation works
1. Periodic rate
The annual rate is divided by the number of payments per year.
2. Regular payment
An amortization formula creates equal principal-and-interest payments.
3. Declining interest
Each payment applies more toward principal as the balance falls.
| Payment | Payment | Principal | Interest | Balance |
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