Interest is the price you pay in percentage form to borrow money from a lender. As you pay back your principal balance each month, you also have to pay back interest, which does add to the overall cost of your loan. There are two primary types of interest, and it's important to know the difference between the two when it comes to calculating your rate.
Simple interest
Simple interest is the easier of the two to calculate and short-terms loans tend to have simple interest rates. To calculate the total interest you will pay over the life of your loan multiply the principal amount by the interest rate and the lending term in years.
Amortized interest
Amortized loans tend to be more complicated. The initial payments for amortized loans are typically interest-heavy, which means that more of the payments are going toward interest than the principal loan balance. As you get closer to the end of your repayment term, more of your monthly payments go toward the principal balance and less toward interest. To calculate the amortized rate, complete the following steps:
- Divide your interest rate by the number of payments you make per year
- Multiply that number by the remaining loan balance to find out how much you will pay in interest that month.
- Subtract that interest from your fixed monthly payment to see how much of the principal amount you will pay in the first month.
- For the following month, repeat the process with your new loan balance.
Mortgages, auto loans, student loans and personal loans are typically amortized loans.
Factors that affect how much interest you pay
There are several things that impact the interest rate you are eligible for as well as the overall interest you end up paying on an installment loan:
- Credit score. The better your credit, the more likely you are to qualify for a lender’s lowest interest rates. Your credit score indicates to lenders how likely you are to pay back a loan. If you have bad credit, you are likely to receive a higher interest rate so that the lender can make sure it makes its money back even if you default on the loan.
- Debt-to-income ratio. If you have a high amount of monthly debt compared to your income a lender is likely to assign you a higher interest rate. If you currently have several high interest loans, it could be worth looking into debt consolidation in order to lower your monthly payment and simplify your bills.
- Loan amount. The more money you borrow, the higher your interest rate will be. When you take out a large loan, the lender is taking on more risk than if you were to take out a smaller loan. To cut down on interest, make sure you only borrow what you need.
- Loan term. Shorter loan terms come with higher monthly payments, but you end up paying less interest overall. Longer repayment terms come with lower monthly payments, but you end up paying more in interest.
- Type of loan. Loans can either be secured or unsecured. Secured loans tend to have lower interest rates because they are backed by collateral. However, that does mean that you risk losing an asset such as your home or car if you fail to pay back the loan.Personal loans are typically unsecured, meaning that they tend to have higher interest rates than secured loans.
How inflation affects interest rates
The higher the rate of inflation, the higher interest rates will typically trend. Similarly, if inflation is slowing, interest rates tend to drop, too. This is in part because banks anticipate the decreased purchasing power of the interest earned during periods of high inflation.
To get the lowest possible interest rate on your loan, compare top lenders before you apply. If possible, prequalify with a few lenders to see what terms you are eligible for without making a commitment or undergoing multiple hard credit checks within a short period of time.
FAQs
If you have a 6 percent interest rate and you make monthly payments, you would divide 0.06 by 12 to get 0.005. Multiply that number by your remaining loan balance to find out how much you'll pay in interest that month. If you have a $5,000 loan balance, your first month of interest would be $25.
How do you calculate interest only on a loan? ›
To calculate interest-only loan payments, multiply the loan balance by the annual interest rate, and divide it by the number of payments in a year. For example, interest-only payments on a $50,000 loan with a 4% interest rate and a 10-year repayment term would be $166.67.
How to calculate loan interest formula? ›
To calculate interest rates, use the formula: Interest = Principal × Rate × Tenure. This equation helps determine the interest rate on investments or loans. What are the advantages of using a loan interest rate calculator?
How much would a $8000 loan cost per month? ›
Example Monthly Payments on an $8,000 Personal Loan
| Payoff period | APR | Monthly payment |
|---|
| 12 months | 15% | $722 |
| 24 months | 15% | $388 |
| 36 months | 15% | $277 |
| 48 months | 15% | $223 |
3 more rowsAug 31, 2021
Based on the OneMain personal loan calculator, a $5,000 loan with a 25% APR and a 60-month term length would be $147 per month. The loan terms you receive will depend on your credit profile, including credit history, income, debts and if you secure it with collateral like a car or truck.
How to calculate simple interest? ›
Simple interest is calculated by multiplying the principal, the amount of money that is initially invested or borrowed, by the rate, the speed at which the interest grows, and the time, how long money is being invested or borrowed. In other words, the formula for simple interest is I = P R T .
How do you calculate monthly interest? ›
Simply divide your APY by 12 (for each month of the year) to find the percent interest your account earns per month. For example: A 12% APY would give you a 1% monthly interest rate (12 divided by 12 is 1). A 1% APY would give you a 0.083% monthly interest rate (1 divided by 12 is 0.083).
How much is a $20,000 loan for 5 years? ›
A $20,000 loan at 5% for 60 months (5 years) will cost you a total of $22,645.48, whereas the same loan at 3% will cost you $21,562.43. That's a savings of $1,083.05. That same wise shopper will look not only at the interest rate but also the length of the loan.
How much is a $25,000 loan payment? ›
The monthly payment on a $25,000 loan ranges from $342 to $2,512, depending on the APR and how long the loan lasts. For example, if you take out a $25,000 loan for one year with an APR of 36%, your monthly payment will be $2,512.
How much is a $15000 loan a month? ›
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| Loan Amount | Loan Term (Years) | Estimated Fixed Monthly Payment* |
|---|
| $10,000 | 5 | $207.54 |
| $15,000 | 3 | $463.09 |
| $15,000 | 5 | $313.13 |
| $20,000 | 3 | $617.45 |
13 more rowsMortgage type
| Mortgage Amount | Interest Rate | Interest-only Payments (Monthly) |
|---|
| £250k | 4.5% | £938 |
| £250k | 5% | £1,042 |
| £250k | 5.5% | £1,146 |
| £250k | 6% | £1,250 |
2 more rowsFor example, say you borrow $100,000 at a 5% interest rate. Your calculation would look like this: (100,000 x . 05)/12 = 416.67. This means that your interest-only payment would be $416.78 per month. Payments will then increase to those of a typical, amortized loan, covering both principal and interest.
How do you manually calculate interest on a loan? ›
To calculate simple interest on a loan, multiply the principal (P) by the interest rate (R) by the loan term in years (T), then divide the total by 100. To use this formula, make sure you're expressing your interest rate as a percentage, not a decimal (i.e., a rate of 4% would go into the formula as 4, not 0.04).
Is interest calculated only on the principal? ›
With simple interest the interest is calculated only once during the entire time period of the loan or deposit. Simple interest is calculated solely on the principal investment or loan. With compound interest the interest is calculated more than once during the time period of the loan.
