diff --git a/app/controllers/loans_controller.rb b/app/controllers/loans_controller.rb
index ec98cfa..678d6fd 100644
--- a/app/controllers/loans_controller.rb
+++ b/app/controllers/loans_controller.rb
@@ -1,14 +1,14 @@
 class LoansController < ActionController::API
 
   rescue_from ActiveRecord::RecordNotFound do |exception|
-    render json: 'not_found', status: :not_found
+    render json: { error: 'not_found' }, status: :not_found
   end
 
   def index
-    render json: Loan.all
+    render json: Loan.all.as_json(methods: [:outstanding_balance])
   end
 
   def show
-    render json: Loan.find(params[:id])
+    render json: Loan.find(params[:id]).as_json(methods: [:outstanding_balance])
   end
 end
diff --git a/app/controllers/payments_controller.rb b/app/controllers/payments_controller.rb
new file mode 100644
index 0000000..be63c46
--- /dev/null
+++ b/app/controllers/payments_controller.rb
@@ -0,0 +1,34 @@
+class PaymentsController < ActionController::API
+  before_action :set_loan
+
+  rescue_from ActiveRecord::RecordNotFound do |exception|
+    render json: { error: 'not_found' }, status: :not_found
+  end
+
+  def index
+    render json: @loan.payments
+  end
+
+  def show
+    render json: @loan.payments.find(params[:id])
+  end
+
+  def create
+    @payment = @loan.payments.build(payment_params)
+    if @payment.save
+      render json: @payment, status: :created
+    else
+      render json: { errors: @payment.errors.full_messages }, status: :unprocessable_entity
+    end
+  end
+
+  private
+
+  def set_loan
+    @loan = Loan.find(params[:loan_id])
+  end
+
+  def payment_params
+    params.require(:payment).permit(:payment_date, :amount)
+  end
+end
diff --git a/app/models/loan.rb b/app/models/loan.rb
index aa46eda..8be74fe 100644
--- a/app/models/loan.rb
+++ b/app/models/loan.rb
@@ -1,2 +1,8 @@
 class Loan < ActiveRecord::Base
+  has_many :payments
+
+  # Calculates the outstanding balance: funded_amount minus total payments made
+  def outstanding_balance
+    funded_amount - payments.sum(:amount)
+  end
 end
diff --git a/app/models/payment.rb b/app/models/payment.rb
new file mode 100644
index 0000000..346174a
--- /dev/null
+++ b/app/models/payment.rb
@@ -0,0 +1,16 @@
+class Payment < ActiveRecord::Base
+  belongs_to :loan
+
+  validates :payment_date, presence: true
+  validates :amount, presence: true, numericality: { greater_than: 0 }
+  validate :amount_does_not_exceed_outstanding_balance
+
+  private
+
+  def amount_does_not_exceed_outstanding_balance
+    existing_total = loan.payments.where.not(id: self.id).sum(:amount)
+    if loan && amount && (existing_total + amount > loan.funded_amount)
+      errors.add(:amount, "exceeds the outstanding balance of the loan")
+    end
+  end
+end
diff --git a/config/routes.rb b/config/routes.rb
index 89db866..e47ebfb 100644
--- a/config/routes.rb
+++ b/config/routes.rb
@@ -1,3 +1,5 @@
 Rails.application.routes.draw do
-  resources :loans, defaults: {format: :json}
+  resources :loans, only: [:index, :show], defaults: { format: :json } do
+    resources :payments, only: [:index, :show, :create], defaults: { format: :json }
+  end
 end
diff --git a/db/migrate/20250313061519_create_payments.rb b/db/migrate/20250313061519_create_payments.rb
new file mode 100644
index 0000000..5f811bf
--- /dev/null
+++ b/db/migrate/20250313061519_create_payments.rb
@@ -0,0 +1,11 @@
+class CreatePayments < ActiveRecord::Migration[5.2]
+  def change
+    create_table :payments do |t|
+      t.references :loan, null: false, foreign_key: true
+      t.date :payment_date, null: false
+      t.decimal :amount, precision: 15, scale: 2, null: false
+
+      t.timestamps
+    end
+  end
+end
diff --git a/db/schema.rb b/db/schema.rb
index 3b0f090..9eb546a 100644
--- a/db/schema.rb
+++ b/db/schema.rb
@@ -10,7 +10,7 @@
 #
 # It's strongly recommended that you check this file into your version control system.
 
-ActiveRecord::Schema.define(version: 20150903195334) do
+ActiveRecord::Schema.define(version: 2025_03_13_061519) do
 
   create_table "loans", force: :cascade do |t|
     t.decimal "funded_amount", precision: 8, scale: 2
@@ -18,4 +18,13 @@
     t.datetime "updated_at", null: false
   end
 
+  create_table "payments", force: :cascade do |t|
+    t.integer "loan_id", null: false
+    t.date "payment_date", null: false
+    t.decimal "amount", precision: 15, scale: 2, null: false
+    t.datetime "created_at", null: false
+    t.datetime "updated_at", null: false
+    t.index ["loan_id"], name: "index_payments_on_loan_id"
+  end
+
 end
diff --git a/spec/controllers/loans_controller_spec.rb b/spec/controllers/loans_controller_spec.rb
index 312463a..0e4fd8a 100644
--- a/spec/controllers/loans_controller_spec.rb
+++ b/spec/controllers/loans_controller_spec.rb
@@ -1,25 +1,36 @@
 require 'rails_helper'
 
 RSpec.describe LoansController, type: :controller do
-  describe '#index' do
-    it 'responds with a 200' do
-      get :index
+  let!(:loan) { Loan.create!(funded_amount: 1000) }
+  let!(:payment) { Payment.create!(loan: loan, payment_date: Date.today, amount: 200) }
+
+  describe "GET #index" do
+    it "returns loans with the outstanding balance included" do
+      get :index, format: :json
       expect(response).to have_http_status(:ok)
+      json = JSON.parse(response.body)
+      expect(json.first).to have_key("outstanding_balance")
+      expect(json.first["outstanding_balance"].to_f).to eq(800.0)
     end
   end
 
-  describe '#show' do
-    let(:loan) { Loan.create!(funded_amount: 100.0) }
-
-    it 'responds with a 200' do
-      get :show, params: { id: loan.id }
-      expect(response).to have_http_status(:ok)
+  describe "GET #show" do
+    context "with a valid id" do
+      it "returns a loan with its outstanding balance" do
+        get :show, params: { id: loan.id }, format: :json
+        expect(response).to have_http_status(:ok)
+        json = JSON.parse(response.body)
+        expect(json).to have_key("outstanding_balance")
+        expect(json["outstanding_balance"].to_f).to eq(800.0)
+      end
     end
 
-    context 'if the loan is not found' do
-      it 'responds with a 404' do
-        get :show, params: { id: 10000 }
+    context "with an invalid id" do
+      it "returns a 404 not_found response" do
+        get :show, params: { id: 0 }, format: :json
         expect(response).to have_http_status(:not_found)
+        json = JSON.parse(response.body)
+        expect(json["error"]).to eq("not_found")
       end
     end
   end
diff --git a/spec/controllers/payments_controller_spec.rb b/spec/controllers/payments_controller_spec.rb
new file mode 100644
index 0000000..9f3a443
--- /dev/null
+++ b/spec/controllers/payments_controller_spec.rb
@@ -0,0 +1,44 @@
+require 'rails_helper'
+
+RSpec.describe PaymentsController, type: :controller do
+  let!(:loan) { Loan.create!(funded_amount: 1200) }
+  let!(:payment) { Payment.create!(loan: loan, payment_date: Date.today, amount: 500) }
+
+  describe "GET #index" do
+    it "returns a list of payments for a loan" do
+      get :index, params: { loan_id: loan.id }, format: :json
+      expect(response).to have_http_status(:ok)
+      json = JSON.parse(response.body)
+      expect(json.size).to eq(1)
+    end
+  end
+
+  describe "GET #show" do
+    it "returns a specific payment" do
+      get :show, params: { loan_id: loan.id, id: payment.id }, format: :json
+      expect(response).to have_http_status(:ok)
+      json = JSON.parse(response.body)
+      expect(json["id"]).to eq(payment.id)
+    end
+  end
+
+  describe "POST #create" do
+    context "with valid attributes" do
+      it "creates a new payment" do
+        post :create, params: { loan_id: loan.id, payment: { payment_date: '2025-03-13', amount: 500 } }, format: :json
+        expect(response).to have_http_status(:created)
+        json = JSON.parse(response.body)
+        expect(json["amount"].to_f).to eq(500.0)
+      end
+    end
+
+    context "with invalid attributes" do
+      it "returns errors when payment exceeds the outstanding balance" do
+        post :create, params: { loan_id: loan.id, payment: { payment_date: '2025-03-13', amount: 900 } }, format: :json
+        expect(response).to have_http_status(:unprocessable_entity)
+        json = JSON.parse(response.body)
+        expect(json["errors"]).to include("Amount exceeds the outstanding balance of the loan")
+      end
+    end
+  end
+end
diff --git a/spec/models/payment_spec.rb b/spec/models/payment_spec.rb
new file mode 100644
index 0000000..7f9793a
--- /dev/null
+++ b/spec/models/payment_spec.rb
@@ -0,0 +1,21 @@
+require 'rails_helper'
+
+RSpec.describe Payment, type: :model do
+  let(:loan) { Loan.create!(funded_amount: 10000) }
+
+  it "is valid with a payment amount within the outstanding balance" do
+    payment = Payment.new(loan: loan, payment_date: Date.today, amount: 4500)
+    expect(payment).to be_valid
+  end
+
+  it "is invalid if the payment amount exceeds the outstanding balance" do
+    
+    Payment.create!(loan: loan, payment_date: Date.today, amount: 5000)
+    Payment.create!(loan: loan, payment_date: Date.today, amount: 4000)
+    Payment.create!(loan: loan, payment_date: Date.today, amount: 800)
+    
+    payment = Payment.new(loan: loan, payment_date: Date.today, amount: 300)
+    expect(payment).not_to be_valid
+    expect(payment.errors[:amount]).to include("exceeds the outstanding balance of the loan")
+  end
+end