How to Calculate Loan Payments and Costs

How to Calculate Loan Payments and Costs
Written by Publishing Team

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Loans can be a critical lifeline in unexpected times of crisis, or a tool that makes upward mobility possible — as long as lenders understand the costs.

“Personal loans can help you cover almost any purchase or consolidation of higher interest debt,” says Leslie Taine, founder and chief attorney at Tyne Law Group that specializes in consumer debt. Common uses include paying for home improvements, medical bills, or unexpected expenses.

Explains Matt Lattman, Vice President of Personal Loans Company at Discover Loans.

However, even if you get a fixed repayment period and amount, you may not know exactly how the lender calculates your monthly payment. And this is important: Understanding how loan payments are calculated gives you insight into the total cost of the loan, as well as how you can save money.

Here’s what you need to know about calculating a loan repayment and how it can affect the amount you pay back over time.

How do personal loans work?

Personal loans are usually unsecured, which means you don’t need collateral to get them. You receive a lump sum from the lender, and the money can be used for a number of purposes.

Tayne explains that many personal loans have a fixed interest rate and accumulate what’s known as simple interest. “The interest you pay will be based only on the principal, as opposed to compound interest where interest accrues on additional interest,” she says.

Since a personal loan usually has a fixed interest rate and payment and is fully amortized – which means it will be paid off in full at the end of the loan term – you will know the total number of loan payments from the start and can plan accordingly.

amortizing loans

An amortized loan is a type of loan structure designed to reduce what you owe over time. It ensures that your payment is applied first to the interest accrued during the pay period before it is applied to principal. Most personal loans, along with mortgages and auto loans, are loan amortization.

With personal loans amortized, Lattman says, your monthly payments are split between interest and principal. The interest is usually accrued daily over the life of the loan, and the daily interest fee will change as the principal balance is paid off, he explains. At the start of the loan, a higher percentage of your payments may go to interest charges. By the end of the loan term, though, the bulk of your monthly payments will go toward the principal reduction.

“Amortization is really just a arithmetic problem of figuring out how much principal you have to pay each month in order to keep the repayment amount the same, and to make sure the full amount is paid off at the end of the loan,” Lattman says.

Let’s say you take out a $15,000 loan with an annual interest rate of 6.99% for 72 months. Using the amortization schedule created with NextAdvisor’s Loan Calculator, you can see how much of your monthly payments go into interest, how much goes toward principal, and how those numbers change each month.

Date Total amount paid Total interest paid Total paid up capital Balance
January 11 2022 $255.66 USD 86.39 USD 169.27 $14,831.72
February 11, 2022 $255.66 USD 85.41 $170.25 14662.45 USD
March 11, 2022 $255.66 $84.42 $171.24 $14492.20
April 11, 2022 $255.66 USD 83.42 $172.24 $14,320.96
May 11 2022 $255.66 USD 82.42 $173.24 14148.72 USD
11 June 2022 $255.66 $81.41 174.25 USD $13975.47
11 July 2022 $255.66 USD 80.39 $175.27 $1,801.22
August 11, 2022 $255.66 USD 79.37 USD 176.29 $13,625.95

You can learn how to start this process for the first several months of payment. At the end of the amortization table, below, you can see how almost nothing is trending toward interest, and the last payment is the principal of the entire amount.

Date Total amount paid Total interest paid Total paid up capital Balance
August 11, 2027 $255.66 $5.87 USD 249.79 $1,008.19
September 11, 2027 $255.66 $4.42 251.24 USD USD 758.40
October 11, 2027 $255.66 $2.95 USD 252.71 $507.16
November 11, 2027 $255.66 $1.48 USD 254.18 USD 254.45
December 11, 2027 $255.66 $0.00 $255.66 $0.27

There is a small balance left at the end of this example, which can easily be paid off.

Interest only loans

In some cases, you may be able to get an interest-only loan. Tayne explains that when you take out this type of loan, you only start making the interest payments. While this can give you some nice breathing space at first, it’s easy to get late when your regular payments hit the road. And in some cases, you will be required to pay off the entire remaining balance as a lump sum, which can be difficult.

Interest-only loans aren’t very common with personal loans, according to Atman, and are more likely to be encountered as a type of mortgage. An interest-only HELOC is another popular type of interest-only loan.

loan repayment account

In theory, calculating a loan payment is simple. You take the total amount you borrowed (known as your principal), and divide it by the number of months during which you agreed to repay the loan (known as the term).

However, it gets tricky when calculating the interest fee. Interest is expressed as an annual percentage, or APR, although most people make payments on a monthly basis. If your interest rate is 6.99%, for example, you cannot add just 6.99% to your principal each month. Instead, your monthly interest is a fraction (one-twelfth) of what you pay over the year (6.99%) – in this case 0.5825%.

Loans can be complex enough without adding algebra into the mix. If you don’t want to write the accounts yourself, you can use the loan repayment cost calculator to easily find out your monthly obligation, and also see the total amount you will pay in interest. But if you’re interested in the detailed math, here’s the formula that lenders use to calculate your monthly payments for an amortized personal loan:

a = q {[r(1+r)n ]/ [(1+r)n-1]}

A = The amount of the monthly payment (what it is due to)
P = capital (what you borrowed)
r = monthly interest rate (annual interest rate divided by 12 months)
n = loan term in months

Using the previous example of a $15,000 loan with a 6.99% APR for 72 months, here’s what you get when you plug in the numbers:

A = 15000 [(0.005825 x 1.00582572) / (1.00582572 – 1)]

A = 15,000 (0.008849 / 0.519198)

A = $255.65

In the example above, your monthly payments would be around $256.

Incorporation fee

To add another layer, some lenders will also charge a fee for their loans. According to Tayne, lenders usually charge what’s known as an origination fee, which is essentially a one-time administration fee that is collected at the time of loan acceptance and receipt.

Tyne says the set-up fee typically ranges from 1% to 8% of your loan balance. Instead of adding them to your loan balance, you can expect the fees to be deducted from the amount you receive.

“So if you borrow $5,000 and the build-up fee is 5%, you will only receive $4,750 when the lender cashes you,” says Taine. “However, you will still pay interest on the entire $5,000.”

How to pay off loans faster

One way to reduce the total cost of your loan is to pay it off faster. When you make additional payments to the principal amount, you can generally reduce the amount you pay and pay off the loan before the original term expires.

However, you will want to check the exact terms before signing for a loan. Some lenders charge penalties for prepaying the loan before the end of your term. When looking for a lender, be sure to find one that does not impose prepayment penalties. Getting out of debt faster aims to save money; You don’t want to end up paying more instead.

In addition to paying extra toward your principal, Lattman and Tayne recommend the following tips to get out of your debt faster:

  • Avoid borrowing more than you need
  • Cut discretionary spending and put savings toward debt reduction
  • Refinance for a shorter term or at a lower interest rate
  • Find ways to increase your income and invest the extra money in debt reduction
  • Use the windfall to make a lump sum payment for your capital

When deciding if a personal loan is right for you, look beyond the APR and consider the effect it will have on your budget.
“In addition to your annual interest rate (APR), it is critical that you look at the amount of the monthly payment and the term of repayment and see how it fits into your budget,” Lattman says. Can you plan on, say, $250 a month for three years? If not, you may need to rethink.”

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