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 (interest-only or amortizing) will determine the loan payment formula and how interest is calculated.
- Using a loan calculator can help determine the exact monthly payments for a loan, making it easier to budget and avoid mistakes.
- It's important to calculate the total cost of a loan to understand how much it costs monthly and long term.
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 in principal and interest payments. Four elements make up your monthly payment, regardless of type.
- 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.
- Interest rate: An interest rate is the amount lenders charge for lending money, expressed as a percentage. Your interest is mostly determined by your credit score. The higher your score is, the lower your rate and monthly payment will be.
- 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. However, you’ll pay more interest over the life of a loan with a longer term.
- Fees: Most loan types require you to pay origination fees as part of the loan costs. The fees you’ll be charged not only vary by lender but also by loan type. Some lenders will allow you to increase your rate to cover the costs, resulting in a higher monthly payment. Others require you pay the costs out of pocket when you close or deduct them from your loan funds.
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
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
Calculation of loan repayment using a calculator
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.
If you make less than a 20 percent down payment or take out a loan backed by a government agency like the Federal Housing Administration (FHA), you’ll notice that your monthly payment includes mortgage insurance. This insurance covers the lender’s risk if you can’t repay your loan and the lender has to foreclose and re-sell your home.
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.
How to save money on loan interest payments
Interest is one of the biggest expenses related to taking out a loan. The lower your interest rate, the less extra money you’ll pay on top of what you borrowed. While it’s not always possible to lower your interest rate, some strategies could help you save money on your loan initially and over time.
Get prequalified with multiple lenders
Prequalifying for a loan allows you to see the repayment terms and interest rates you qualify for with a specific lender without impacting your credit. When shopping for any kind of loan, prequalify with at least three lenders so you can compare offers side by side and choose the most favorable one.
Ask your local bank or credit union about interest rate or fee discounts if you already bank with them. Many online lenders offer lower rates if you set up an automatic payment arrangement through your bank.
Improve your credit score before you apply
Your credit score plays the biggest role in the interest rate you pay. If you don’t need money immediately, pay down your credit card balances or — better yet — pay them off. This will boost your credit utilization ratio and improve your score so you qualify for much lower interest rates in the future.
Make extra payments toward your loan principal
If you can’t afford a shorter term, make an extra payment toward your principal whenever you can to reduce your total loan balance and the total interest you owe. A bonus: You’ll pay your loan off faster.
Pay your loan off early
If you receive a considerable sum from a bonus or tax refund, using it to pay off your loan early could save you hundreds, if not thousands, in interest charges. Check with your lender to ensure there isn’t a prepayment penalty before going this route.
Use a 0 percent introductory APR credit card
See if you qualify for a card that offers a 0 percent APR for a set amount of time. Depending on the card offer, you could avoid paying interest for 12 to 18 months.
A 0 percent APR card can be a good alternative to a personal loan and can help you pay off a large purchase without facing huge interest payments. That said, if you don’t pay the card’s balance off by the time the introductory offer is over, you may pay interest much higher than most loans.
Borrow only what you need
One of the most straightforward ways to limit the overall interest you pay is to reduce the total amount of money you borrow. The less you borrow, the less interest you’ll pay.
Crunch the numbers carefully before deciding how much of a loan you want to apply for, and only borrow what you need. Consider splitting up your purchase between cash and a loan to reduce the total interest you pay.
Frequently asked questions
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Always look at your current budget before you borrow money. Can you handle a new payment based on how much money you spend on your lifestyle? If you don’t know your credit score, check it before applying. Once you are ready to borrow, always shop around, compare rates and fees and choose the lender with terms that fit your financial goals.
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Your payment history affects your credit scores most, so even a 30-day late payment will tank your score quickly. You may also rack up late payment fees, have debt collectors calling you nonstop or even be sued in court if you default on the loan.
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A prepayment penalty is a fee a lender charges if you pay off some or all of a loan before a set period. These penalties are more common in bad credit lending scenarios. They are also a common feature of HELOCs and may be called early closure or termination fees.
