Consider an initial loan amount of $1,000, at 2 percent interest per month for 6 months, with equal monthly installment payments of $178.53 per month. In the first month, interest is equal to the balance of $1,000 multiplied by 2 percent interest, or $20. In Month 1, the installment payment of $178.53 was allocated as: $20 to interest and principal reduction of $158.53.
This means that at the beginning of Month 2, the loan balance equals $1,000 minus the loan reduction of $158.53, or $841.47. Interest expense equals 2 percent multiplied by $841.47, or $16.83. The loan reduction this time is equal to $178.53 minus interest expense of $16.83, or $161.70. Continuing this exercise through Month 6 results in total loan reduction of $1,000 and total interest expense paid of $71.15, the sum of which happens to equal $1071.15. This figure, $1071.15, also is equal to the sum of the six monthly installment payments of $178.53.