Making a big purchase, consolidating debt, or covering emergency expenses with the help of financing feels great in the moment - until that first loan payment is due. Suddenly, all that feeling of financial flexibility goes out the window as you factor a new bill into your budget. No matter the dollar amount, it's an adjustment, but don't panic. Maybe it's as simple as reducing your dining out expenses or picking up a side hustle. Let's focus on your ability to make that new payment on time and in full.
Of course, before you take out a personal loan, it's important to know what that new payment will be, and yes, what you'll have to do to pay your debt back. Whether you're a math whiz or you slept through Algebra I, it's good to have at least a basic idea of how your repayment options are calculated. Doing so will ensure that you borrow what you can afford on a month-to-month basis without surprises or penny-scrounging moments. So let's crunch numbers and dive into the finances of your repayment options to be sure you know what you're borrowing.
Don't worry - we're not just going to give you a formula and wish you well. Ahead, we'll break down the steps you need to learn how to calculate your loan's monthly payment with confidence.
How do you calculate a loan payment?
The first step to calculating your monthly payment actually involves no math at all - it's identifying your loan type, which will determine your loan payment schedule. Are you taking out an interest-only loan or an amortized loan? Once you know, you'll then be able to figure out the types of loan payment calculations you'll need to make.
With interest-only loan options, you only pay interest for the first few years, and nothing on the principal balance - the loan itself. While this does mean a smaller monthly payment, eventually you'll be required to pay off the full loan in a lump sum or with a higher monthly payment. Most people choose these types of loan options for their mortgage to buy a more expensive property, have more cash flexibility, and to keep overall costs low if finances are tight.
The other kind of loan is an amortized loan. These loan options include both the interest and principal balance over a set length of time (i.e., the term). In other words, an amortized loan term requires the borrower to make scheduled, periodic payments (an amortization schedule) that are applied to both the principal and the interest. Any extra payments made on this loan will go toward the principal balance. Good examples of an amortized loan are an auto loan, a personal loan, a student loan, and a traditional fixed-rate mortgage.
What is my loan payment formula?
Now that you have identified the type of loan you have, the second step is plugging numbers into a loan payment formula based on your loan type.
If you have an amortized loan, calculating your loan payment can get a little hairy and potentially bring back not-so-fond memories of high school math, but stick with us and we'll help you with the numbers.
Here's an example: let's say you get an auto loan for $10,000 at a 7.5% annual interest rate for 5 years after making a $1,000 down payment. To solve the equation, you'll need to find the numbers for these values:
A = Payment amount per period
P = Initial principal or loan amount (in this example, $10,000)
r = Interest rate per period (in our example, that's 7.5% divided by 12 months)
n = Total number of payments or periods
The formula for calculating your monthly payment is:
A = P (r (1+r)^n) / ( (1+r)^n -1 )
When you plug in your numbers, it would shake out as this:
P = $10,000
r = 7.5% per year / 12 months = 0.625% per period (0.00625 on your calculator)
n = 5 years x 12 months = 60 total periods
So, when we follow through on the arithmetic you find your monthly payment:
10,000 (.00625 x (1.00625^60) / ((1.00625^60) - 1)
10,000 (.00625 x 1.45329) / (1.45329 - 1)
10,000 (.00908306 / .45329)
10,000 (.02003808) = $200.38
In this case, your monthly payment for your car’s loan term would be $200.38.
If you have an interest-only loan, calculating the monthly payment is exponentially easier (if you'll pardon the expression). Here is the formula the lender uses to calculate your monthly payment:
loan payment = loan balance x (annual interest rate/12)
In this case, your monthly interest-only payment for the loan above would be $62.50.
Knowing these calculations can also help you decide which loan type would be best based on the monthly payment amount. An interest-only loan will have a lower monthly payment if you're on a tight budget, but again, you will owe the full principal amount at some point. Be sure to talk to your lender about the pros and cons before deciding on your loan.
What if the math still doesn't add up?
If these two steps made you break out in stress sweats, allow us to introduce to you our third and final step: use an online loan payment calculator. You just need to make sure you're plugging the right numbers into the right spots. The Balance offers this Google spreadsheet for calculating amortized loans. This loan calculator from Calculator.net can do the heavy lifting for you or your calculator, but knowing how the math breaks down throughout your loan term makes you a more informed consumer.
How to pay less interest on your loan
Ah, interest charges. You simply cannot take out a loan without paying them, but there are ways to find lower interest rates to help you save money on your loans and overall interest throughout the loan term. Here are a few of our simplest tips for getting a reduced rate:
Check out a local, community financial institution. When you're shopping around for the best rate, you might be surprised to find out that a credit union or smaller financial institution offers lower interest rates on a personal loan, student loan, or mortgage. It might take some time, but the money saved could be worth the extra effort to bank local.
Pay off any current debt, or at least as much as you can. Whether it's from a credit card or federal loans, paying down your debt will allow your credit utilization rate to lower, which will then, in good time, raise your credit score.
Set up automatic payments. If you set up auto-pay for your personal loan, car loan, mortgage, or other kind of loan, you might be able to lower your interest rate. (Be sure to check with your financial institution to see if this is an option first.) This is because with autopay, banks are more likely to be paid on time and don't need to worry if you'll make your payment each month.
Improve your credit score. One of the best ways to guarantee a lower interest rate (and potentially reduce it for any current loans you may have) is to have an excellent credit score. However, this step doesn't come as quickly as other steps in the borrowing process, especially if you have bad credit. Start by catching up on any past due payments, keep your credit utilization ratio below 20%, and check your credit report for any errors. Check out this list of highly effective ways to improve your credit score if you're serious about getting your number into excellent credit territory.
How to get the best deal on a loan
This one is simple: get a loan that helps you manage your monthly payments.
Now that you know how to calculate your monthly payment, and understand how much loan you can afford, it's crucial you have a game plan for paying off your loan. Making an extra payment on your loan is the best way to save on interest (provided there isn't a prepayment penalty). But it can be scary to do that. What if unexpected costs come up like car repairs or vet visits?
The Kasasa Loans® is the only loan available that lets you pay ahead and access those funds if you need them later, with a feature called Take-BacksTM. They also make managing repayments easy with a mobile-ready, personalized dashboard. Ask your local, community financial institution or credit union if they offer Kasasa Loans®. (And if you can’t find them in your area, let us know where we should offer them here!)
Taking out a loan can feel overwhelming given all the facts and figures (especially the figures), but being armed with useful information and a clear handle on your monthly payment options can ease you into the process. In fact, many of the big-ticket items like homes or cars just wouldn't be possible to purchase without the flexibility of a monthly loan payment. As long as you budget carefully and understand what you're getting into, this credit-building undertaking isn't hard to manage - or calculate - especially if you keep a calculator handy.