Updated: May 17, 2024
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Taking on a loan is a significant financial commitment, so ensuring your monthly payments will be within your budget is important. You are less likely to fall behind if you know your loan's full terms and conditions before you start making payments. MoneyGeek's guide explains how these payments work, how to calculate them and the essential terminology.
Calculating your monthly payments helps tailor your budget to ensure you efficiently meet your loan repayment requirements.
Consider the principal, interest rate and loan terms to calculate your monthly loan payments.
The formula for your monthly payments can change based on whether your loan is interest-only or amortizing.
Loan payments are your method of repaying borrowed money to the lender, typically every month. The payment includes the principal and interest over a set period until you repay the loan in full. Before taking out a loan, understand the factors that influence your monthly loan payments to ensure you can afford them:
Principal
The principal is the initial amount you borrow. The larger your principal, the higher your monthly payment will be, as the loan repayment includes paying down this original sum and interest. For example, if you borrow $20,000 for a personal loan, your principal is $20,000.
Loan Term
The term of your loan dictates how long you have to repay it. A longer loan term means smaller monthly payments spread over more time, while a shorter term means larger payments over a shorter period. Personal loan terms typically range from one to seven years, with two to five years being the most common range many lenders offer. Residential mortgage loan terms are typically 30 years.
Interest Rate
The interest rate is the cost your lender charges for borrowing their money, and it significantly impacts your monthly payments. Factors like your credit score, debt-to-income ratio and loan repayment terms determine the interest rate.
With an interest-only loan, all of your monthly payment goes toward the loan’s interest for a pre-set period. During this time, the principal remains unchanged. This is common in mortgages and home equity lines of credit with interest-only draw periods. You won’t typically find this option with personal loans.
The formula to calculate your monthly loan payment is: P = a (r / n)
Where:
To use this formula, divide your interest rate by the number of payments you make in a year (usually 12). Multiply this result by your principal to find out your monthly loan payment.
For instance, you take out a $50,000 mortgage and receive a 5% interest rate. Your interest-only period lasts five years. You can use the formula to determine how much you'll need to pay back each month.
Divide your interest rate by the number of payments in a year (12) to get your monthly interest rate:
Then, multiply this monthly interest rate by your principal amount to calculate your monthly payment:
Your monthly payment for the interest-only period comes out to be approximately $208.
When the interest-only period of your loan ends, you'll start paying off the principal in addition to the interest — that means your payments will go up. You might consider paying off the remaining balance in a lump sum or refinancing your mortgage for a potentially lower interest rate.
Amortizing loans are installment loans where you're required to make regular payments over a predetermined period. Each payment is split into two parts: one portion reduces your principal balance, and the other covers the interest on the loan. Common examples of amortizing loans are personal loans and auto loans.
To calculate your monthly payment for an amortizing loan, use the following formula:
Where:
To use this formula, determine your loan's principal amount and the annual interest rate, then convert that interest rate into a monthly rate by dividing it by 12. Next, figure out the total duration of your loan in months. By inserting these values into the formula, you can calculate the exact monthly payment amount.
Imagine you take out a $25,000 personal loan with a 5-year term and a 10% interest rate, lower than the current 12.49% average interest rate for a 24-month personal loan. You can calculate your monthly payment using the formula.
Calculate the periodic interest rate (r) by dividing the annual interest rate by 12:
Then, determine the total number of months (n) in the loan term:
Next, plug in the values into each group of the equation:
Divide the results from step 3:
Finally, divide the principal amount by the result obtained in step 4:
That means, for the $25,000 personal loan at a 10% annual interest rate over a 5-year term, your monthly payment is approximately $531.18.
Before taking out a loan, use our loan calculator to fully understand your financial commitment. Simply enter your loan amount, interest rate and term length to quickly get a detailed overview of your potential monthly payments along with a comprehensive amortization schedule.
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Updated: Jul 26, 2024
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Finding ways to reduce the interest you pay on a loan can lead to significant savings over the long term. Here are some strategies to help you pay less in interest:
Compare lenders
Shop around and compare offers from different lenders to find the lowest interest rates. A lower rate means less interest to pay over the life of your loan. Also look at different loan type options, such as fixed vs. variable rates and secured vs. unsecured loans.
Improve your credit score
A higher credit score can qualify you for lower interest rates. Take steps to improve your credit by paying bills on time and reducing your debt.
Reduce your loan term
Choosing a shorter loan term means higher monthly payments, but you'll pay less interest overall. This strategy can save you money if you can afford the higher monthly outlay.
Make additional payments
Paying more than the minimum due each month reduces your principal balance faster, decreasing the amount of interest you accrue.
Pay off your loan early
If possible, paying off your loan before its term ends can save you on the interest that would have been accumulated. That said, check if your loan has any prepayment penalties before doing so.
Refinancing can potentially allow you to get a better interest rate on your loan under the right circumstances:
Before refinancing, consider refinancing costs, such as processing fees or penalties for early repayment of your existing loan. — Alvin Yam, CFP
We answered some frequently asked questions about loan payments to help you manage your finances.
Missing a loan payment can lead to late fees, a potential increase in your interest rate and a negative impact on your credit score. Most lenders offer a grace period, so immediately discuss any available options with your lender.
A shorter loan term usually means higher monthly payments but less interest paid over time. A longer loan term lowers monthly payments but increases the total interest paid. Your choice should depend on your monthly budget and financial goals.
An amortization schedule is a table detailing each payment on an amortizing loan (like a mortgage). It shows how much of each payment goes toward the principal and how much toward interest, as well as the remaining balance after each payment.
Yes, if interest rates have dropped or your credit score has improved since you took out your original loan, refinancing can be a good option to lower your interest rate and reduce your monthly payment.
A prepayment penalty is a fee that some lenders charge if you pay off your loan early. It's important to know if your loan includes this fee before making extra payments or refinancing.
Defaulting on your loan payments negatively impacts your credit score, which can affect your chances of obtaining credit in the future. If you have a secured loan, you may lose the asset you put up as collateral. Your lender may forward your debt to a collection agency whose sole responsibility is to get you to repay your loan.
The content on this page is accurate as of the posting/last updated date; however, some of the rates mentioned may have changed. We recommend visiting the lender's website for the most up-to-date information available.
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