Before taking out a personal loan, you should understand how much the monthly payments will be and whether your budget can comfortably accommodate the additional expense. However, determining the exact installment payments prior to establishing a new loan can be challenging.
When you borrow money from a lender, you are not simply repaying the principal. Interest, which is the cost of borrowing money, will be included in the monthly installment payments. Here are some methods for calculating what your monthly installment payments might be.
How to Make Personal Loan Payments
In addition to the principal amount of your loan, you must pay interest and any fees associated with a personal loan. You can break down the costs in your loan by:
- The principal is the amount borrowed that is deposited into your account.
- Interest: The fee charged by the lender for lending you money. Your annual percentage rate (APR) includes your interest rate as well as any upfront costs you paid, such as origination fees. Most personal loans have a fixed interest rate, which means your monthly payments will remain constant throughout the loan’s term. Your credit score and history determine your interest rate; the higher your credit score, the lower your interest rate.
- Fees: Additional loan costs such as origination fees, late fees, insufficient funds fees, and so on.
- The debt and repayment term determine your monthly payment. Because the payments are spread out over a longer period, a $5,000 loan paid over five years will have lower monthly payments than a $5,000 loan paid over three years. Keep in mind, however, that your interest rate and any associated fees are added to each loan payment.
The loan repayment formula
The simple loan payment formula takes into account your loan principal, interest rate, and loan term. The principal amount is spread out evenly over the term of your loan repayment, as are the interest charges. Although the number of years in your term may vary, you will typically receive 12 payments per year.
The type of loan you have determines which loan calculator you will need to use to calculate your payments. There are interest-only loans and loans that include both principal and interest.
Loans with only interest
Interest-only loans require you to pay only the interest on the loan for a set period of time. During that time, the amount of principal you owe will remain constant. Monthly loan payments are simple to calculate.
Let’s calculate your costs if you have a $20,000 loan with a 6% APR and a 10-year repayment term. In this case, you would multiply the amount borrowed by the interest rate. This figure represents your annual interest costs, which are divided by 12 months:
Every year, $20,000 x 0.06 = $1,200 in interest
$1,200 divided by 12 months equals $100 in monthly interest.
Of course, interest-only loans do not last indefinitely. When your loan’s interest-only period expires, you must repay the principal amount borrowed. After the interest-only period expires, most interest-only loans become amortizing loans, requiring you to make monthly payments on principal and interest.
Loan amortization
Amortizing loans apply a portion of your monthly payment to your principal balance and interest.
Automobile loans are a type of amortizing loan. Assume you took out a $20,000 auto loan with a 6% APR and a five-year repayment period. Here’s how you’d figure out loan interest payments.
Divide your interest rate by the number of payments you’ll make each year, which is usually 12 months.
Multiply that figure by the loan’s initial balance, which should be the full amount borrowed.
The loan payment formula for the figures above would be:
- 0.06 divided by 12 equals 0.005 0.005 x $20,000 equals $100
- That $100 is the amount of interest you’ll pay in the first month. However, as you pay down your loan, more of your payment goes toward principal and less toward interest. You can calculate your monthly interest payment by repeating the above calculation with your new, lower loan balance.
How to Determine Total Loan Costs
Because the total cost of a loan is determined by the amount borrowed, the length of time it takes to repay it, and the APR, even loans of similar size may have drastically different total costs.
The most important factor in calculating total loan cost is your APR. Because it is the amount you pay to your lender, a higher APR implies a higher cost. To determine the exact difference, use a calculator or the loan amortization formula.
A $20,000 loan with a 48-month term, for example, will cost more than twice as much with a 10% APR as with a 5% APR — the difference between paying $4,350 and $2,100. And, because lenders are legally allowed to charge up to 36% APR, you may be forced to pay a significant amount in interest even if you borrow a small amount for a short period of time.
| 5% APR | 8% APR | 10% APR | |
|---|---|---|---|
| Monthly payment | $460.59 | $488.26 | $507.25 |
| Total interest paid | $2,108.12 | $3,436.41 | $4,348.08 |
The second factor to consider is the loan term. A longer loan term means paying less each month but paying more in interest overall. You can change your monthly payment by extending your loan term, but if you want to pay less, choose the highest monthly payment you can afford in order to pay off your loan as quickly as possible.
For example, if you choose to pay off a $20,000 loan over 36 months rather than 60 months, you will save $1,000.
| 36-month term | 48-month term | 60-month term | |
|---|---|---|---|
| Monthly payment | $599.42 | $460.59 | $377.42 |
| Total interest paid | $1,579.05 | $2,108.12 | $2,645.48 |
Fees will also be a factor. If you intend to pay off your loan early, weigh the amount you will save on interest against the prepayment fee. In some cases, it may be less expensive to choose a loan with a higher APR but no early payment penalty.
The same is true of an origination fee. With a higher origination fee, you will receive less money because it is typically a percentage of the loan amount. While it is deducted from the total loan funds you receive, you will still be required to pay interest on the entire loan amount borrowed. Even so, a loan with a higher origination fee but a lower interest rate may be cheaper. Using a calculator, compare the total cost of each loan to determine which is the better financial option.
How to Reduce Loan Interest Payments
One of the most expensive aspects of borrowing money is interest. The lower your interest rate, the less money you’ll have to pay in addition to what you borrowed. While lowering your interest rate is not always possible, some strategies may help you save money on your loan over time.
Prequalify yourself. You’ll be able to compare rates from many lenders if you can see what size loan you qualify for without completing a full loan application and risking being denied. When you shop around, you can find the lender with the best interest rate, fees, and repayment terms.
Make additional loan principal payments. You will only have one loan payment per month. Some of that will be applied to your principal and some to interest. Make an extra payment toward your principal whenever possible. This will reduce your total loan balance as well as the interest you owe. Because interest is charged upfront on amortizing loans, the sooner you do this, the better.
Pay off your loan early. You will pay less interest over the life of the loan if you can afford higher monthly payments or pay your remaining loan balance in a lump sum. Before you go this route, make sure there isn’t a prepayment penalty.
Use a credit card with a 0% introductory APR. This card offers 0% APR for a set period of time, which can range from 12 to 18 months depending on the offer. This allows you to pay off a large purchase without incurring large interest payments. However, if you do not pay off the card’s balance by the end of the introductory period, interest payments will begin, often at a much higher rate.
Borrow only what you require. One of the most straightforward ways to reduce your overall interest payments is to borrow less money. The less you borrow, the less interest you will pay on the loan. Consider your options carefully before deciding how much of a loan you want to apply for, and only borrow enough to cover the costs you hope to cover with the loan.
In conclusion
When taking out a loan, make sure you understand your monthly repayment obligations. The payments will include both the principal and interest on the loan. There may be additional fees associated with the loan.
Use an online loan payment calculator before submitting your loan application to help you understand what your payments might be. Remember that many strategies, such as not borrowing more than you need and paying off your loan early, can help you save money on payments over time.
