How Do You Calculate Payments On A Loan?

When you take out a loan, there are usually two main payments; the principal amount and the interest. They must be paid back together. Although in some cases, the lender may require you to first clear the interest. Then, you can repay the principal amount.

Interest is the fee you pay for the privilege of using someone’s money. In this case, you are using the bank’s money. This is how they make money through loans since banks are not non-profit organizations.

There are various methods of calculating the payments on a loan. Each lender tends to have its own system. To learn more about calculating loan payments, continue reading.

How Do You Calculate Payments On A Loan?
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Types of Loans

Interest-only loans mean that you are only required to repay the interest charged on the loan in the first few years. During that time, you will not pay any principal. However, there are also other formats your loan could follow.

Amortized loans mean that you will be paying both the interest and the loan with every installment. The lender will have a specific amortized schedule and a formula that allocates some of the money towards the principal and the rest towards the interest.

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Loan Calculations

Sometimes , it’s not possible to do the calculations by hand. Therefore you may need to use a loan calculator. There are plenty of these online. You could also use a spreadsheet program such as Microsoft Excel or Google Sheets.

Each of these options will allow you to complete the calculations and see the exact amount of money you will pay per month.  

The Amortized Loan Formula

For purposes of this formula, the monthly payment will have the value (p), the total loan amount will be (a) and the periodic interest is represented by (r)  is the annual interest rate, which is divided by the payment periods. The total loan term shall be (n). Here is the formula.

Formula: a/ {[(1+r) ^n]-1}/[r (1+r) ^n] =p

It may seem a bit complicated. This is why most people choose to use an online loan calculator.

But, let’s just try and use it for purposes of understanding what goes on in a loan calculation.

For example, let’s assume you have borrowed a loan worth $100,000, with an interest rate of 6% over 30 years. If the loan was to be repaid monthly, then the formula would be as follows.

  • a: represent the loan amount – 100,000
  • r: is the annual interest – 0.06. When this is divided by the number of months – 12, the monthly interest shall be 0.005.
  • n: represents the period. For 30 years, with 12 months a year, the time will be 360

Here’s the calculation

100,000/{[(1+0.005)^360]-1}/[0.005(1+0.005)^360]=599.55, or 100,000/166.7916=599.55

The monthly loan payments will be $599.55 each month.

Alternatively, you could use Credit Karma to calculate this payment.

Interest-only payment formula

When calculating the payments for an interest-only loan. You will multiply the amount you borrow (a) with the total interest per year (r) and then divide this number by the number of yearly payments (n).

  • Formula:a*(r/n) or (a*r)/12

Let’s use the same example above. The interest-only payment. Loan amount $100,000 given for 30 years at 6% interest.

  • a: 100,000 is the amount of the loan
  • r: 0.06 represents the interest rate expressed as 0.06
  • n: this is the monthly installments

Monthly Payment: 100,000*(0.06/12) =500, or 100,000*0.005=500

Credit Card Payments

Calculating credit card payments is fairly simple. Lenders usually use a formula that helps them calculate the minimum monthly installment based on your total balance. It is always wiser to pay more than the required minimum due each month. The minimum is, however, the amount you should pay to avoid late payment charges.

So, for example, you owe $7,000 on your card and the minimum payment is usually 1% of the balance. Then you will be required to pay = $7,000 X 10/100 = $70 each month.

This figure does not include any late fees or penalties you may have been charged.

The Total Cost Of The Loan

It is a bit difficult to understand the exact amount you will pay for the loan when considering different lenders. Therefore, it is important to carefully consider all of the repayment terms.

Most lenders also seem to have plenty of hidden charges such as late payment charges, application charges, loan amortization charges, early payment fees, etc. SO, ensure that you read the fine print you receive from the lender before committing yourself to their loan.

How Do You Calculate Payments On A Loan?
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Conclusion

Loans are sometimes necessary, especially when starting a business, buying a house, or paying for school. However, it is always important to remember that loans must be repaid. Failure to do so will negatively affect your credit.

Only take out what you need, and diligently repay the loan when the payments are due. If possible, repay more than needed, so you can clear the loan faster than expected.

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