How to Calculate Loan Payments

One of the most important things to establish before taking a loan is your monthly payments or installments. You also need to know the interest rate and the duration to complete the loan. Knowing how to calculate loan payments can help you find these answers and choose a lender that can accommodate your financial needs.

Understanding Monthly Loan Payments

Different types of loans have different payment approaches. There are two main types of loans:

• Amortizing loans: These are installment loans that require regular payments for a predetermined period. Each monthly payment covers both the principal and the interest on the loan. Examples of amortizing loans are personal loans, mortgages, and car loans.
• Interest-only loans: This type of loan requires you to pay only the interest on the principal for a fixed period. Eventually, you'll have to pay back the principal, either through higher monthly payments or as a lump sum. Home equity loans and personal lines of credit are often interest-only loans.

Four main elements make up your monthly loan payment, regardless of the type of loan you take:

• Principal: This is the total amount of money you borrow.
• Interest rate: The interest rate is the amount the lender charges the borrower for the loan. It is usually expressed as an annual percentage rate (APR).
• Fees: Additional fees may include late fees, origination fees, and prepayment penalties.
• Repayment terms: This is the time you have to repay the loan, for example, 24 months or 60 months.

Using a Payment Formula

The calculation formula you use depends on the type of loan you have, whether it is amortizing or interest-only. If you're repaying an amortized loan, a loan payment formula can help you understand what portion of your payment goes to the principal and what goes to the interest. To calculate monthly loan payments, you'll need to know the principal, loan term, and interest rate. While you can use a calculator for quick calculations, understanding the mechanics can help you be a more informed borrower.

Calculating Interest-Only Payments

The principal amount for interest-only loans remains unchanged as you pay the monthly interest for a specific period. This means you only need to calculate the amount of interest you're supposed to pay each month.

To calculate the monthly interest, multiply the loan balance by the annual interest rate and divide the result by the number of payments in a year, which is typically 12. For example, payments for an interest-only loan of $300,000 at a 3% interest rate would be $750:

• $300,000 x 0.03 = $9,000
• $9,000 / 12 = $750

Calculating Amortizing Loan Payments

Payment for amortized loans is set using amortization tables. The principal is spread equally over your loan repayment term. You'll typically have 12 payments each year, although the term may vary in the number of years.

Typically, your monthly payment will remain the same over the life of the loan. As you continue paying installments for the amortized loan, a larger portion of your payment goes toward the principal balance and less toward the interest. The interest is charged on reducing balance, which means that every month, your interest is calculated on the outstanding balance, not the entire loan amount.

Lenders often provide a loan amortization schedule because the calculations can seem complicated. However, you can calculate payments yourself with a few different formulas.

First, find your monthly interest rate by dividing the APR by 12. Then, calculate the total number of payments by multiplying the loan term in years by 12. For example, a $300,000 loan at a 3% interest rate for 10 years would have a monthly interest rate of 0.25% and 120 payments.

• 0.03 / 12 = 0.0025 x 100 = 0.25%
• 10 x 12 = 120

Next, calculate the total monthly payment with this formula:

• Loan amount x {[M x (1+M)^P]/[(1+M)^P - 1]} = Total monthly payment

Where M is the monthly interest rate and P is the total number of payments.

For our example, the monthly payment is $2,891.48:

• $300,000 x {[0.0025 x (1+0.0025)^120]/(1+0.0025)^120 - 1]}
• $300,000 x {[0.0025 x 1.35]/[1.35 - 1]}
• $300,000 x {0.0034/0.35}
• $300,000 x 0.0096
• $2,891.48

To determine how much of that payment goes toward the principal, you also need to know the outstanding loan balance. Then use this formula:

• Total monthly payment - (outstanding balance x monthly interest rate) = principal payment

For our example, the amount going toward the principal for the first payment is $2,141.48:

• $2,891.48 - ($300,000 x 0.0025)
• $2,891.48 - $750
• $2,141.48

When the outstanding balance reaches $100,000, the amount going toward the principal is $2,641.48:

• $2,891.48 - ($100,000 x 0.0025)
• $2,891.48 - $250
• $2,641.48

Fixed Rate vs. Variable Rate Loans

Amortized loans can further be categorized into fixed-rate loans and variable-rate loans. Fixed-rate loans are assigned a specific rate that doesn't change over the duration of the loan. You can easily calculate the amount of interest you'll pay since the rate is constant. The interest charged on these loans is also known as simple interest.

To calculate simple interest on a loan, you'll need the principal amount, loan term, and interest rate. Multiply the principal by the interest rate, then multiply the result by the loan term in years. This formula gives you the total simple interest for the loan. For a loan of $15,000 at 5% interest and a five-year term, the simple interest is $3,750.

Most amortizing loans use daily simple interest, where interest is calculated daily and added to the outstanding balance. Although the monthly payment is fixed, the amount of interest you pay changes based on the outstanding balance.

The interest rate for variable-rate loans can change during an adjustment period based on various factors, such as the federal funds rate. The interest on this type of loan may also include the margin, which is the additional interest the bank adds on. Predicting the interest amount for variable-rate loans is more complex because of possible fluctuations over the term of the loan.

Calculating Payments Using Calculators

Many lenders provide loan calculators borrowers can use to determine interest payments and principal balances. To properly use these tools and get accurate results, you must know what information to feed the calculator. Different types of loans have different structures, making it necessary to have a specific calculator for a specific type of loan. Examples include:

• Auto loan calculator
• Student loan calculator
• Mortgage calculator
• Personal loan calculator
• Home equity calculator 
• Home equity line of credit (HELOC) calculator

Avoid these mistakes when using loan calculators:

• Forgetting processing fees and other charges: You may concentrate on the principal and interest amounts and forget additional charges. You may have to add fees and charges separately from the loan calculator. Overlooking the charges means you won't get an accurate estimate of the amount you'll owe the lender.
• Neglecting the loan term: The loan duration is as important as the principal and interest rate.
• Entering the wrong loan amount or interest rate: Double-check the principal and interest rate you enter for calculations. Wrong figures can lead to huge differences between the equated monthly installment (EMI) and the actual amount you have to repay.

Tips on Saving Money While Repaying Loans

After finding out the loan payments you're supposed to make, you may wonder how you can save money as you repay the loan. These tips can help you save money:

• Make extra payments: You can make extra payments — pay more than the minimum installment for each month — to apply to the principal. A lower principal balance means less interest paid because the interest is charged on the principal balance.
• Pay the loan early: You can pay off the loan early in a single lump sum to save money on interest. Before taking the loan, check with your lender to see if they allow early repayment.
• Limit borrowing: You can also save money by limiting your borrowing as much as possible.
• Improve your credit score: Your credit score influences the interest rate charged on your loan. A higher credit score generally means a lower interest rate.
• Shorten the loan term: Although you'll have higher monthly payments for a loan with a short term, you'll eventually pay less compared to a longer-term loan.

Partner With Atlas Credit for Credit Solutions

Knowing how to work out monthly interest can help you compare lenders, find favorable terms, and make informed decisions about your borrowing. You can turn to Atlas Credit for affordable online loans.

We provide access to affordable loans to underserved customers. If you've been turned down by banks or other lenders, we are here to help you. You can complete an easy loan application online, over the phone or by visiting our branch locations.