How to calculate loan payments and costs
Key takeaways
- Your payment is calculated based on your interest rate and repayment period.
- The type of loan will determine the loan payment formula and how interest is calculated.
- Using a loan calculator can help you estimate your monthly payments, making it easier to budget and avoid mistakes.
- When comparing options, look at the monthly cost and total cost to see the full picture of how much you’ll repay.
Knowing how to calculate your loan payments and costs can help you choose the best loan for your short- and long-term financial plans if you’re considering borrowing money. Once you understand the basic loan payment calculation formula, you can run numbers on any type of financing, whether it’s a personal loan, an auto loan or a mortgage.
Alternatively, you can use a loan calculator, and all the math is done for you. That way, you can focus on which payment, interest rate and terms are best for your needs.
Using a loan calculator can give you a general idea of what to expect with any type of loan payment without filling out an application. Try different loan terms, annual percentage rates (APRs) and loan amounts to compare the differences in cost.
How loan payments work
Several moving parts make up your monthly loan payment. You’ll have an amortizing payment if you choose an installment loan, like a personal loan. That means each month you’ll pay a portion of your loan balance off along with interest until the loan is paid in full.
You can also choose an interest-only loan, allowing you to only pay the interest charge each month for a set period. After that period ends, you pay the balance off through principal and interest payments.
Regardless of the type of loan you choose, there are four elements that make up your monthly payment:
- Principal: This is the total amount you borrow when taking out a loan. It’s also the amount you pay each month to reduce the loan balance.
- Interest rate: An interest rate is the amount lenders charge for lending money, expressed as a percentage. Your interest is primarily determined by your credit score.
- Repayment term: This is the amount of time you have to repay the loan. The longer the repayment period, the less you’ll pay each month — but you’ll pay more interest with longer loan terms.
- Principal: This is the total amount you borrow when you first take out a loan. It’s also the amount you pay each month to reduce your loan balance with an amortizing loan.
- Fees: Loans often have fees, primarily an origination fee. The amount you pay varies by lender and is often deducted from loan proceeds.
How to use a loan payment formula
The formula for calculating your loan payment depends on whether you choose an amortizing or interest-only loan. Examples of amortizing loans include car loans, mortgages and personal loans. Home equity lines of credit (HELOCs) are examples of loans that typically offer an interest-only payment option.
Amortizing loans
Amortizing loans apply some of your monthly payment toward your principal balance and interest. The payment is calculated using the simple loan payment formula.
Your principal amount is spread equally over your loan repayment term. While you may choose the number of years in your term, you’ll typically have 12 payments each year. To calculate how many payments you’ll make in your loan term, multiply the number of years by 12.
Car loans are a type of amortizing loan. Let’s say you took out an auto loan for $20,000 with an APR of 6 percent and a five-year repayment timeline. Here’s how you would calculate loan interest payments.
- Divide your interest by the number of payments you’ll make each year. Usually, the number is 12 — one payment per month.
- Multiply that figure by the initial balance of your loan, which should start at the full amount you borrowed. For the figures given, the loan payment formula would look like:
- 0.06 divided by 12 = 0.005
- 0.005 x $20,000 = $100
Sample amortization schedule
In this example, you’d pay $100 in interest in the first month. As you continue to pay your loan off, more of your payment goes toward the principal balance and less toward interest. You can figure out each month’s principal and interest payments and see how your loan balance drops with each payment.
| Starting loan balance | Monthly payment | Paid toward principal | Paid toward interest | New loan balance | |
|---|---|---|---|---|---|
| Month 1 | $20,000 | $387 | $287 | $100 | $19,713 |
| Month 2 | $19,713 | $387 | $288 | $99 | $19,425 |
| Month 3 | $19,425 | $387 | $290 | $97 | $19,136 |
| Month 4 | $19,136 | $387 | $291 | $96 | $18,845 |
| Month 5 | $18,845 | $387 | $292 | $94 | $18,552 |
| Month 6 | $18,552 | $387 | $294 | $93 | $18,258 |
| Month 7 | $18,258 | $387 | $295 | $91 | $17,963 |
| Month 8 | $17,963 | $387 | $297 | $90 | $17,666 |
| Month 9 | $17,666 | $387 | $298 | $88 | $17,368 |
| Month 10 | $17,368 | $387 | $300 | $87 | $17,068 |
| Month 11 | $17,068 | $387 | $301 | $85 | $16,767 |
| Month 12 | $16,767 | $387 | $303 | $84 | $16,464 |
How to calculate interest-only payments
With interest-only loans, you’re responsible for paying only the interest on the loan for a specified length of time. For example, many home equity lines of credit let you make interest-only payments for the first 10 years. This can help you manage your monthly budget if you’re using the funds for an ongoing project like a home renovation.
The amount of principal you owe will stay the same during the interest-only period, which means you only need to do an interest calculation to figure out your monthly payment.
- $20,000 x 0.06 = $1,200 in interest each year
- $1,200 divided by 12 months = $100 in interest per month
How to calculate total loan costs
The total cost of a loan depends on the amount you borrow, how long you take to pay it back and the annual percentage rate. The APR is the most important factor — it reflects the total amount you’ll pay for borrowing money. This includes the interest rate and any fees charged by the lender.
You can use a calculator or the simple interest formula for amortizing loans to get the exact difference you’ll pay with different APRs. And since lenders can legally charge APRs into the double digits, you may get stuck paying a significant amount in interest — even if you borrow a small amount for a short time — if you don’t compare rates.
For example, a $20,000 loan with a 48-month term at 10 percent APR costs $4,350. Compare that to the $2,100 you’ll spend for a 5 percent APR, and you can see the importance of getting the lowest APR possible when you borrow money.
| 5% APR | 8% APR | 10% APR | |
|---|---|---|---|
| Monthly payment | $460.59 | $488.26 | $507.25 |
| Total interest paid | $2,108.12 | $3,436.41 | $4,348.08 |
The repayment term length can also greatly impact the total cost of your loan. A longer term means you pay less monthly, but more over the life of the loan.
For example, you’ll save a little over $1,000 in interest charges on a $20,000 loan with a 5 percent APR if you pay it off in 36 months versus 60 months.
| 36-month term | 48-month term | 60-month term | |
|---|---|---|---|
| Monthly payment | $599.42 | $460.59 | $377.42 |
| Total interest paid | $1,579.05 | $2,108.12 | $2,645.48 |
Fees will also play a role. If you plan to pay off your loan ahead of schedule, see if the lender charges any prepayment penalties or fees for paying off your loan early. In some cases, it may cost less to go with a loan with a higher APR but no prepayment penalty.
The same goes for an origination fee. Since it is typically a percentage of the loan amount, you’ll get less of the stated loan amount with a higher origination fee. And while it is usually deducted from the total loan funds you receive, you will still pay interest on the full loan amount you borrow.
Even still, a loan with a higher origination fee but a lower interest rate may be less expensive. Compare the total cost of each loan using a calculator to determine which is the better financial choice.
Calculators for estimating potential costs
If you’re not a fan of complicated math formulas, let a loan calculator do all the hard work. Whether you’re buying a house and need a mortgage or need quick cash from a personal loan to pay for an emergency car repair, there’s a calculator available for you to crunch numbers.
- A personal loan calculator allows you to compare the payments on a variety of loan terms and interest rates, which typically range from one to seven years and around 8 to 36 percent.
- If you’re considering a student loan to pay for college or trade school, you can use a student loan calculator to estimate how much you’ll pay when you graduate.
- Before heading to the dealership or looking online for a car, you can view potential car payments with an auto loan calculator based on different loan amounts, repayment terms and interest rates.
- A mortgage calculator is a good way to decide if you’re financially ready to be a homeowner. It can help you determine how much house you can afford and how your down payment amount affects the monthly payment.
- A home equity line of credit calculator lets you crunch numbers based on how much you borrow from your revolving line of credit. To get accurate figures for a specific repayment timeline, you’ll need a general idea of the APR and the annual fee, if there is one.
- A home equity loan is like a personal loan with fixed interest rates and payments, except your home secures it. If you need to take this type of loan, use a home equity loan calculator that shows how much your payment would be on the 10-, 15- or even 30-year terms most home equity loan lenders offer.
Bottom line
Loan payments are calculated based on your interest rate and repayment period. The type of loan, whether its interest-only or amortizing, also plays a role in how interest is calculated.
Understanding these factors and using an online loan calculator can help you develop a clear picture of the overall costs associated with a loan, helping you to decide what works best for your budget and financial needs.
