A Simplified Guide on How to Calculate Loan Payments

A loan is a commitment. Whether your loan lasts only two years or stretches into the next 15, you must make a conscious effort to ensure you make your monthly payments. Knowing how much you have to set aside means you’re less likely to miss payments once you begin repayments.

MoneyGeek’s guide walks you through the steps so you can calculate your monthly payments. We’ll clarify some essential terminology before moving on to the actual computations.

Doing a little planning can make creating a household budget easier — you may even realize that you have enough funds to make additional payments, which can get you out of debt sooner.

You must gather specific information to learn how to calculate your monthly loan payments accurately. This includes the amount you borrowed, the interest rate your lender charges and how long you have to repay your loan.

As the name implies, monthly payments for interest-only loans go entirely to your interest. This continues for a specific duration, which is your interest-only period.

Once your interest-only period ends, your loan turns into an amortizing loan, which the next section discusses in detail. However, let’s focus on your financial obligations while you’re still in the interest-only period.

The formula below shows how to calculate your loan payment each month.

The formula might seem complex, but it doesn’t have to be. Using example figures for the formula may make it easier to understand, so let’s start from there.

Let’s say you applied for a 15-year fixed-rate mortgage. You need $275,000 to purchase your dream home. After submitting your loan application, your lender offers you a 5% annual interest rate for your loan amount. Your interest-only period lasts for ten years.

Let’s use the formula above to calculate your loan payment each month.

• First, let’s divide your rate by 12 since you’ll make monthly payments (5% ÷ 12 = 0.00416667)
• Next, multiply your current figure by your principal (0.00416667 x 275,000 = 1,145.83)
• P = $1,145.83 (this is your monthly payment during the interest-only period)

Remember, once the interest-only period ends, you’ll also begin paying for your principal. You have multiple options regarding how you want to move forward.

You can continue to make monthly payments, including payments toward your principal balance. This generally results in a higher payment amount. Alternatively, you could pay off your entire balance in a lump sum or refinance your mortgage, if possible.

An amortizing loan is an installment loan, and you must make regular payments over a specific duration. A part of each payment goes towards your principal, and a portion serves as a payment for your interest. Personal loans and auto loans are excellent examples of amortizing loans.

Computing the monthly payments for an amortizing loan requires a slightly different formula, which the box below provides.

Looking at a long formula can be daunting, so let’s apply it to a loan scenario. Let’s say you take out a $30,000 car loan. Your lender charges you 5% interest, slightly higher than 4.55%, the average as of the end of Q1 2022 for a 60-month loan.

Use these figures and calculate your car loan payments.

Let’s start by dividing the formula into more manageable parts:

We'll refer to the section in blue as X, and the one in violet as Y. P = a ÷ (X ÷ Y) is a less complicated way of looking at it.

Next, we’ll calculate for X.

• Begin by dividing your interest rate by 12 to get r (5% ÷ 12 = 0.0041667)
• Add 1 (1 + 0.0041667 = 1.0041667)
• Raise the sum to the total number of months of your loan term (1.004166760 = 1.2833587)
• Subtract 1 from your current number (1.2833587 - 1 = 0.2833587)
• X = 0.2833587

Then we’ll compute for Y.

• Like X, we start with dividing your interest rate by 12 to get r (5% ÷ 12 = 0.0041667)
• Add 1 (1 + 0.0041667 = 1.0041667)
• Raise the sum to the total number of months of your loan term (1.004166760 = 1.2833587)
• Multiply your current figure by r (0.0041667 x 1.2833587 = 0.0053474)
• Y = 0.0053474

Now, we’ll divide X by Y and refer to the result as Z.

• 0.2833587 + 0.0053474 = 52.989995.
• Z = 52.989995

Last, we’ll divide your principal (A) by Z to get your monthly payment (P).

• 30,000 + 52.989995 = 566.14
• P = $566.14 (this is you monthly payment)

Before you apply for a loan, try out our loan calculator. Simply enter the loan amount, interest rate, and term length. You'll immediately receive a detailed overview of your potential monthly payments and a comprehensive amortization schedule, helping you make an informed decision.

Knowing how to calculate your loan payments puts you at an advantage. However, finding ways to pay less in interest saves you more money in the long term. Here are some strategies to consider:

• Compare lenders: Interest rates and loan terms vary between lenders even if you're borrowing the same amount. Shopping around and comparing estimates helps you see which lender offers the best deal.
• Improve your credit score: Your lender is more likely to charge a lower interest rate if you have a good credit score. Borrowers with good to excellent credit standing usually get the most competitive interest rates.
• Shorten your loan term: Lenders view borrowers with longer loan repayment terms as riskier. In turn, they tend to charge higher interest rates.
• Set up an automatic payment schedule: Some lenders offer a discount for automatic payment because it assures them you'll repay your loan in full and on time.
• Make larger down payments on mortgages or auto loans: The higher your down payment, the lower the amount you'll need to finance. A lower principal amount makes your monthly payments more manageable, too.
• Make additional payments: Paying more than the required amount allows you to repay your loan sooner. However, it’s a good idea to find out whether your lender applies a prepayment penalty before proceeding.

Understanding how to calculate loan payments helps manage your finances. However, consider other factors before applying for a loan. MoneyGeek's guide includes the most commonly asked questions connected to this subject to provide you with additional information.