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How to calculate loan repayments and costs

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Loans can be an essential lifeline in times of unexpected crisis or a tool for upward mobility – as long as lenders understand the costs.

“Personal loans can help you cover almost any purchase or consolidate higher interest debt,” says Leslie Tayne, founder and principal attorney of Tayne Legal Group, specializing in consumer credit. Common uses include paying for home improvements, medical bills, or unexpected expenses.

“The borrower receives a lump sum and then repays it through a series of fixed monthly payments for a fixed repayment period, which makes it easier to budget and know exactly when the loan will be repaid,” explains Matt Latteman, vice president of personal loans at Discover the loans.

However, even if you get a fixed repayment period and amount, you may not know exactly how the lender calculates your monthly payment. And this is important: understanding how to calculate loan repayments gives you insight into the total cost of the loan, as well as how you could potentially save money.

Here’s what you need to know about the loan repayment calculation and how it affects the amount you pay back over time.

How Personal Loans Work

Personal loans are usually unsecured, which means you don’t need collateral to get them. You receive a lump sum from the lender and the money can be used for several purposes.

Many personal loans have a fixed interest rate and pay what’s called simple interest, Tayne says. “The interest you pay will be based on principal only, unlike compound interest where interest accrues additional interest,” she says.

Because a personal loan usually has a fixed interest rate and payment and is fully amortized – meaning it will be fully repaid at the end of the loan term – you will know the total number of repayments from the start and can plan your budget accordingly.

Amortizing loans

An amortizing loan is a type of loan structure designed to reduce what you owe over time. It ensures that your payment is first applied to accrued interest during the payment period before it is applied to principal. Most personal loans, as well as mortgages and auto loans, are depreciable loans.

With amortizing personal loans, Lattman says, your monthly payment is split between interest and principal. Interest is generally accrued daily over the term of the loan, and the daily interest charge will change as the principal balance is paid off, he explains. At the start of the loan, a higher percentage of your payment could be allocated to interest charges. At the end of the loan term, however, most of your monthly payment is used to reduce the principal.

“Amortization is really just a math problem of figuring out how much principal you need to pay each month in order to keep the payment amount the same and make sure you’ve repaid it in full at the end of your loan” , says Lattman.

Say you take out a $15,000 loan with an APR of 6.99% for 72 months. Using the amortization chart created with NextAdvisor’s Loan Calculator, you can see how much of your monthly payment goes to interest, how much goes to principal, and how those numbers change each month.

Dated Total amount paid Total interest paid Total capital paid Balance
January 11, 2022 $255.66 $86.39 $169.27 $14,831.72
February 11, 2022 $255.66 $85.41 $170.25 $14,662.45
March 11, 2022 $255.66 $84.42 $171.24 $14,492.20
April 11, 2022 $255.66 $83.42 $172.24 $14,320.96
May 11, 2022 $255.66 $82.42 $173.24 $14,148.72
June 11, 2022 $255.66 $81.41 $174.25 $13,975.47
July 11, 2022 $255.66 $80.39 $175.27 $13,801.22
August 11, 2022 $255.66 $79.37 $176.29 $13,625.95

You can get an idea of ​​how this process begins during the first few months of payment. At the end of the amortization table, below, you can see that almost nothing goes towards interest, and the last payment is entirely in principal.

Dated Total amount paid Total interest paid Total capital paid Balance
August 11, 2027 $255.66 $5.87 $249.79 $1,008.19
September 11, 2027 $255.66 $4.42 $251.24 $758.40
October 11, 2027 $255.66 $2.95 $252.71 $507.16
November 11, 2027 $255.66 $1.48 $254.18 $254.45
December 11, 2027 $255.66 $0.00 $255.66 $0.27

There is a small balance left at the end of this example, which can be easily refunded.

Interest only loans

In some cases, you may be able to get an interest-only loan. When you get this type of loan, Tayne explains, you start out paying interest only. While this might give you some wiggle room at first, it’s easy to fall behind when your normal payments come down the road. And in some cases, you will have to pay the entire remaining balance in one lump sum, which can be difficult to do.

Interest-only loans aren’t very common with personal loans, according to Lattman, and are more likely to be encountered as a type of mortgage. An interest-only HELOC is another common type of interest-only loan.

Loan repayment calculation

In theory, calculating your loan repayment is simple. You take the total amount you borrowed (called your principal) and divide it over the number of months you agreed to repay the loan (called the term).

However, this gets tricky when you factor in interest charges. Interest is expressed as an annual percentage rate, or APR, although most people make payments on a monthly basis. If your interest rate is 6.99%, for example, you cannot simply add 6.99% to the principal each month. Instead, your monthly interest is a fraction (one-twelfth) of what you pay in a year (6.99%) – in this case, 0.5825%.

Loans can be complicated enough without adding algebra to the mix. If you don’t want to write the calculations yourself, you can use a loan repayment cost calculator to easily determine your monthly obligation, as well as see the total amount you’ll pay in interest. But if you’re curious about the detailed calculations, here’s the formula lenders use to calculate your monthly payments for an amortizing personal loan:

A = P {[r(1+r)n ]/ [(1+r)n-1]}

A = your monthly payment amount (what you are resolving)
P = the principal (what you borrowed)
r = your monthly interest rate (your annual interest rate divided by 12 months)
n = the duration of the loan in months

Using the previous example of a $15,000 loan with an APR of 6.99% over 72 months, here’s what you get when you enter the numbers:

A= 15,000 [(0.005825 x 1.00582572) / (1.00582572 – 1)]

A = 15,000 (0.008849/0.519198)

A = $255.65

In the example above, your monthly payments would be approximately $256.

Assembly costs

To add another layer, some lenders will also charge fees on their loans. According to Tayne, lenders typically charge what’s called an origination fee, which is essentially a one-time administrative fee charged at the time of loan approval and receipt.

Origination fees typically range from 1% to 8% of your loan balance, Tayne says. Rather than being added to your loan balance, you can expect the fee to be deducted from the amount you receive.

“So if you borrow $5,000 and your origination fee is 5%, you’ll only get $4,750 when the lender disburses you the funds,” Tayne says. “You’ll still pay interest on the full $5,000, though.”

How to repay loans faster

One way to lower the total cost of your loan is to pay it off faster. When you make additional principal payments, you can reduce what you pay overall and pay off the loan before the end of the original term.

However, you will want to check the fine print before signing up for a loan. Some lenders charge prepayment penalties for paying off your loan before the end of your term. When looking for a lender, be sure to find one that does not charge prepayment penalties. Getting out of debt faster is supposed to save you money; you don’t want to end up paying extra instead.

In addition to paying extra for your principal, Lattman and Tayne recommend the following tips for getting out of debt faster:

  • Avoid borrowing more than necessary
  • Reduce discretionary spending and use savings to reduce debt
  • Refinance at a shorter term or at a lower interest rate
  • Look for ways to increase your income and spend the extra money on debt reduction
  • Use windfall gains to make a lump sum payment on your principal

When deciding if a personal loan is right for you, look beyond the APR and consider the impact on your budget.
“In addition to your APR, it’s critical to look at your monthly payment amount and repayment term and see how those fit into your budget,” Lattman says. “Can you plan for, say, $250 a month for three years? If not, you may need to rethink.