"Repayment applied first fully to interest = Compound interest".

This is not taught at any level in educational system. So it is difficult to comprehend.

When loan is taken 2 liabilities are undertaken;

• Lump sum drawn to be repaid. Liability exist when loan is taken.
• Interest, due when time passes & the lump sum remain unpaid. A future contingent liability.

In Commercial practice payments are applied to oldest debt first.

In case of 'Interest Only' loan, each repayment will be allocated only to interest.

In case of Principal and interest loan, each repayment should be allocated between principal & interest.

The lenders would want the repayments applied first fully to interest.

The borrowers would want the repayments applied first fully to the principal owing.

Alternatively, apply repayments to Principal and Interest as half each.

For eg. Principal balance owed on a given date is $300,000, Interest due on that date is $ 3,000, repayment is say $2,020.

$ 2020 is allocated as $1010 to Principal and $1010 to Interest. No one did this in the past.

As a neutral position between the two parties to contract;

Repayments shall be most logically allocated;

Between Principal & Interest in the ratio of amount owed to each of them.  For eg. Principal balance owed on a given date is $300,000, Interest due on that date is $ 3,000, repayment is say $2,020.

Repayment $2020 made on that date be allocated to Principal $ 2000 and Interest $ 20 and so on.

At another date Principal owing may be $4,004 and Interest owing $ 6,006 and the repayment of $2020 be allocated as $ 808 to Principal and $ 1212 to Interest. 

This methods bring adequate balance between the interests of Lender and Borrower.