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How to calculate loan payments in 3 easy steps

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 number, it’s an adjustment — so don’t panic. Maybe it’s as simple as reducing your dining out expenses or picking up a side hustle — what’s most important is that you’re able to make your monthly payments on time and in full.

But let’s back up for a second. Before you take out a loan in the first place, it’s important to know what that monthly figure 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 loan repayment will be calculated. Doing so will ensure that you don’t take out a loan you won’t be able to afford on a month-to-month basis, so there are no surprises or penny-scrounging moments. Plus, we’re big fans of budgeting around here in general. Any opportunity to crunch numbers and dive into our finances is time well spent in our book.

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.

Yes, before you start digging into the numbers, it’s important to first know what kind of loan you’re getting — an interest-only loan or 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 an interest-only loan, you would only pay interest for the first few years, and nothing on the principal balance. While this does mean smaller monthly payments, eventually, you’ll be required to pay off the full loan in a lump sum or with higher monthly payments. Most people choose this type of loan for their mortgage to buy a more expensive property, have more cash flexibility, and to keep overall costs low if things are tight.

The other kind of loan is an amortized loan. These loans include both the interest and principal balance over a set length of time (i.e. the term). In other words, amortized loans require the borrower to make scheduled, periodic payments (or amortization schedule) that are applied to both the principal and the interest. Any extra payments made on this loan will go toward the principal amount. Good examples of an amortized loan is your auto loan, personal loan, student loan, and 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.)

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 (loan amount)

  • r = Interest rate per period

  • 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 (and entered as 0.00625 in your calculator)

  • n = 5 years times 12 months = 60 total periods

 

So, when we plug in the numbers:

10,000 {(.00625 x 1.0062560) / (1.0062560 – 1)}

10,000 {(.00625 x 1.4533)/(1.4533 - 1)}

10,000 (.00908/.4533)           

10,000 (.0200377) = $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 loan payments is a lot easier. The formula is:

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 kind of loan to look for based on the monthly payment amount. An interest-only loan will have a lower monthly payment if you’re on a tight budget for the time being, 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.

 

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 Credit Karma is good too.

To calculate interest-only loan payments, try this loan one from Mortgage Calculator.

 

How to pay less interest on your loan

Ah, interest charges. You simply cannot take a loan out without paying them — but there are ways to find lower interest rates to help you save money on your loans and overall interest payment in the long run. 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 institution offers lower interest rates on loans. It might take some time, but the money saved could be worth the extra effort.

  • Pay any current debt off 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 raise your credit score. (In good time.)

  • Setting up automatic payments. If you set up auto-pay for your personal loan, car loan, mortgage, or other kind of loan, you should 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 the first two — 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 number, 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?

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 a Take-Back®. 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 shouldn’t be a shameful or scary 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 mortgage payment or other monthly loan payment. As long as you budget carefully and understand what you’re getting into, this once-scary undertaking isn’t so hard to manage after all — especially if you keep a calculator close by.

 

 

Tags: Home Ownership, Personal Finance, Debt, Auto Loans