How to Calculate Loan Payments and Costs

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Loans can be a critical lifeline in times of unexpected 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 consolidate higher-interest debt,” says Leslie Tayne, founder and lead attorney at Tayne Law Group, which specializes in consumer debt. Common uses include paying for home improvements, medical bills, or unexpected expenses.

“The borrower receives a lump sum and then pays it back through a series of fixed monthly payments over a fixed payment period, making budgeting easy and knowing exactly when the loan will be paid off,” explains Matt Lattman, vice president of personal loans. at Discover Loans.

However, even if you get a fixed payment amount and period, you may not know exactly how the lender calculates your monthly payment. And it’s important: Understanding how to calculate loan payments gives you an idea of ​​the total cost of the loan, as well as how you could save money.

Here’s what you need to know about loan payment calculation and how it can affect the amount you pay over time.

How personal loans work

Personal loans are generally 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.

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

Because a personal loan typically has a fixed interest rate and payment and is fully amortized, meaning it will be paid off in full at the end of the loan term, you’ll know the total amount of loan payments up front and be able to plan your budget accordingly.

Loan Amortization

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

With personal loan amortization, Lattman says, your monthly payment is divided between interest and principal. Interest typically accrues daily over the life of the loan, and the daily interest charge will change as the principal balance is paid off, he explains. At the beginning of the loan, a higher percentage of your payment could go toward interest rates. However, at the end of the loan term, most of your monthly payment goes toward reducing principal.

“Amortization is really just a math problem to figure out how much principal you need to pay each month to keep the same payment amount and make sure you’ve paid it off in full at the end of your loan.” Latman says.

Let’s say you take out a $15,000 loan at 6.99% APR for 72 months. Using the amortization schedule created with NextAdvisor’s loan calculator, you can see how much of your monthly payment goes to interest, how much goes to principal, and how those numbers change each month.

Date Total amount paid Total interest paid Total capital paid Balance
January 11, 2022 $255.66 $86.39 $169.27 $14,831.72
February 11, 2022 $255.66 $85.41 $170.25 $14,662.45
March 11, 2022 $255.66 $84.42 $171.24 $14,492.20
April 11, 2022 $255.66 $83.42 $172.24 $14,320.96
May 11, 2022 $255.66 $82.42 $173.24 $14,148.72
June 11, 2022 $255.66 $81.41 $174.25 $13,975.47
July 11, 2022 $255.66 $80.39 $175.27 $13,801.22
August 11, 2022 $255.66 $79.37 $176.29 $13,625.95

You can get an idea of ​​how this process begins during the first few months of payment. At the end of the amortization schedule below, you can see how almost nothing goes to interest and the last payment is entirely principal.

Date Total amount paid Total interest paid Total capital paid Balance
August 11, 2027 $255.66 $5.87 $249.79 $1,008.19
September 11, 2027 $255.66 $4.42 $251.24 $758.40
October 11, 2027 $255.66 $2.95 $252.71 $507.16
November 11, 2027 $255.66 $1.48 $254.18 $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 be easily paid off.

interest only loans

In some cases, you may be able to get an interest-only loan. When you get this type of loan, Tayne explains, you only start paying interest. While this can give you a nice break at first, it’s easy to fall behind when your regular payments come later. And in some cases, you’ll be required to pay the entire remaining balance in a lump sum, which can be difficult to do.

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

Loan Payment Calculation

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

However, it gets complicated when interest rates are taken into account. The interest is expressed as an annual percentage rate, or APR, although most people make monthly payments. If your interest rate is 6.99%, for example, you can’t just add 6.99% to the principal every month. Instead, your monthly interest is a fraction (one twelfth) of what you pay over the course of a year (6.99%), in this case 0.5825%.

Borrowings can be complicated enough without adding algebra to the mix. If you don’t want to write the calculations yourself, you can use a loan payment cost calculator to easily calculate your monthly obligation, as well as see the total amount you’ll pay in interest. But if you’re curious about the detailed math, here’s the formula lenders use to calculate your monthly payments for an amortizing personal loan:

A = P {[r(1+r)n ]/ [(1+r)n-1]}

A = the amount of your monthly payment (what you are solving for)
P = the principal (what you borrowed)
r = your monthly interest rate (your annual interest rate divided by 12 months)
n = the term of the loan in months

Using the example above of a $15,000 loan with an APR of 6.99% for 72 months, this is what you get when you enter the numbers:

= 15,000 [(0.005825 x 1.00582572) / (1.00582572 – 1)]

A = 15,000 (0.008849/0.519198)

= $255.65

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

origination fees

To add another layer, some lenders will also charge fees for their loans. According to Tayne, lenders commonly charge what’s known as an origination fee, which is basically a one-time administrative fee charged at the time you accept and receive the loan.

Origination fees typically range from 1% to 8% of your loan balance, says Tayne. Instead of being added to your loan balance, you can expect the fee to be deducted from the amount you receive.

“So if you borrow $5,000 and your origination fee is 5%, then you’ll only receive $4,750 when the lender disburses you the funds,” says Tayne. “However, you will still pay interest on the full $5,000.”

How to pay off loans faster

One way to lower the total cost of your loan is to pay it off faster. When you make additional payments on top of principal, you can reduce what you pay overall and pay off the loan before the original term is up.

However, you’ll want to check the fine print before you sign up for a loan. Some lenders charge prepayment penalties for paying off your loan before the end of your term. When shopping for a lender, be sure to find one that doesn’t charge prepayment penalties. Getting out of debt faster is meant to save you money; you don’t want to end up paying extra instead.

In addition to paying more for your principal, Lattman and Tayne recommend the following tips to get rid of your debt faster:

  • Avoid borrowing more than you need
  • Cut discretionary spending and put savings toward debt reduction
  • Refinance to a shorter term or lower interest rate
  • Find ways to increase your income and put the extra money toward debt reduction.
  • Use the windfall to make a balloon payment against your principal

When deciding if a personal loan is right for you, look beyond the APR and consider the impact on your budget.
“In addition to your APR, it’s critical to look at your monthly payment amount and payment term and see how they fit into your budget,” says Lattman. “Can you plan on, say, $250 a month for three years? If not, you may need to reconsider.”

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