How Is Loan Interest Calculated?

Loan interest is the cost of borrowing money and is typically expressed as a percentage of the loan amount. This percentage represents your interest rate, which is the amount a lender charges you to use their money over a specified period of time.

Borrowers must understand how to figure interest on a loan because it directly affects the total cost of the loan and the monthly payments. It’s also important to distinguish between the two most common calculation methods: simple interest and amortized interest.

In this article, the financial pros at Tower Loan explain how to calculate monthly interest on a loan and how to get the lowest interest rates possible on your loan.

Interest Rate Formula Basics

One key concept to understand when borrowing money is the principal, which is the original amount borrowed. The interest rate is the percentage that your lender charges for lending the money in addition to the original amount borrowed.

Another interest rate formula concept is loan term, which is the amount of time you have to repay your loan. Combined, these three elements dictate how much in total interest you’ll pay. The frequency at which you make loan payments, such as biweekly or monthly, also affects the lending rate formula.

What Is Simple Interest?

Before learning how to calculate interest on a loan, you should understand simple interest, which is only the interest calculated on the original principal while you have your loan.

Simple interest applies to various short-term loans, such as payday loans, federal student loans, and some auto and personal loans. Borrowers who make timely or early payments benefit from simple interest. 

Simple Interest Rate Formula

The interest rate formula for simple interest is the principal multiplied by the interest rate multiplied by the number of years. For example, if you take out a $10,000 loan for three years at a 6% interest rate, multiply $10,000 x 3 x 0.06 to arrive at $1,800 in total interest.

Monthly Payment Calculation Example

To understand how to calculate interest rate per month on loan, add the total interest to your principal and divide by the number of payments you owe. Using the above example, let’s say you have a $10,000 loan with a total interest of $1,800 over 36 months. Add those figures together ($10,000 + $1,800) and divide by 36 months, and you’ll get $327.78 per month.

What Is Amortized Interest?

Meanwhile, amortized interest is the interest that’s recalculated each month based on the amount of principal remaining. This type of interest is more common with mortgages and longer-term auto and personal loans.

With amortized interest, the payments are fixed, but the allocation of principal and interest fluctuates over time. Your earliest payments will primarily go toward the interest; however, subsequent payments mostly go toward the principal.

How to Manually Calculate Amortized Interest

Amortized interest is an integral part of how to calculate interest paid on a loan, and it breaks down into two components. It’s broken down into interest calculated on the remaining balance and principal for the remainder of the monthly payment after the interest is taken out.

Determining the amortized interest rate formula involves dividing the annual interest rate by how many payments you will make annually. This provides your monthly interest rate. Then, multiply the monthly interest rate by the current principal balance to determine your monthly interest.

From there, subtract the monthly interest from your fixed payment to determine the amount applied to the principal. You can then deduct the principal portion from this balance to get a new balance. Repeat this process each month, or consider using an amortization loan interest estimator to automate the calculation.

Sample Amortized Loan Interest Estimator

Let’s say you take out a $5,000 loan for one year at an interest rate of 12%. Here’s how you would calculate the amortized interest:

• Monthly rate: 0.12 / 12 = 0.01
• First-month interest: $5,000 × 0.01 = $50
• Fixed monthly payment: $444.89
• First principal payment: $444.89 – $50 = $394.89
• New balance: $5,000 – $394.89 = $4,605.11

How to Use an Amortization Schedule

An amortization schedule is a detailed table that shows you how each of your payments are split. It helps borrowers see how their repayment process works and the total interest they must pay over time.

You can find online calculators that create amortization tables for you. Keep in mind that with amortized loans, early payoffs save you less money than with simple interest loans because amortized ones are typically front-loaded with interest.

Factors That Impact Interest Owed

Now that you understand how to calculate interest on a loan, it’s time to consider the factors that cause you to pay more or less when you borrow money.

One factor is the loan amount, as larger loans typically come with higher interest rates. Even small increases in interest rate percentages add up to significant costs over time.

Also, longer loan terms result in more interest accrued over time. Borrowers who make more frequent payments can lower their interest owed.

If you have a higher credit score, you may be eligible for lower interest rates. Making extra payments, if allowed, especially when you first receive your loan, can also reduce the total interest costs.

How to Get the Lowest Interest Rates

Tower Loan is committed to helping you get the best interest rates possible on your loan to reduce your overall debt burden. Here are some tips to lower your interest rate formula:

• Pay bills on time to improve your credit score
• Pay down debts to lower your debt-to-income ratio
• Choose a shorter-term loan for less interest
• Shop around and compare reputable lenders
• Consider bringing on a cosigner for better interest rates
• Look into potential autopay discounts
• Buy points on mortgages to lower the long-term rate

How to Calculate Interest Paid on a Loan

Loan calculators are excellent tools for how to figure interest on a loan. With a simple or amortization loan interest estimator, you can input details like your loan’s principal, interest rate, loan length, and payment frequency.

Final Thoughts on How to Calculate Interest on a Loan

Understanding how to calculate interest paid on a loan is helpful because it enables you to borrow smarter and budget your money more accurately. You’ll avoid financial surprises during the loan repayment process and save money in the long run as you pay off your loan in monthly installments.

If you have additional questions about how to calculate interest rate per month on loans, Tower Loan is here to help. All our local branches are staffed with loan professionals available to assist you with a personal loan that fits your budget and meets your urgent needs for quick cash. 

Please call or visit your local branch today or apply online to get the money you need as quickly as possible.