How To Calculate Payments on a Loan (2024 Guide)

Loan repayments are the periodic payments made to a lender in order to pay back any money borrowed. Typically, loan repayments are made on a monthly basis and repayments may consist of two components: the principal and the interest. The principal is the total amount of money you borrowed, while the interest is the cost of borrowing the principal. 

Before taking out a loan, it’s wise to fully understand the repayment structure to ensure you can afford the loan repayments.

How To Calculate Your Loan Repayment

To figure out how to calculate repayment on a loan, you’ll need to understand what type of loan you have. Is it a fixed-rate loan, a variable-rate loan or an interest-only loan? Once you know this information, gather the following data:

• Principal balance
• Interest rate
• Loan term

It’s important to ensure the data you gather is accurate. Using estimates instead of specific numbers can skew your entire calculation, making it difficult to know for sure whether you can afford the cost of a loan repayment. 

To correctly calculate the repayment of a loan, there are a few different variables to keep in mind, including the following:

• Principal
• Interest
• Term/repayment period

Principal

The principal of the loan is the initial sum of money that is borrowed and gradually paid over time. Below is an example of how the principal decreases as more payments are made.

Imagine you sign up for a new credit card with a promotional period of 0% interest for six months. In this case, you would only be responsible for paying back the principal during that period of time. 

If you were to make a purchase for $5,000 using that credit card and planned to pay back the entire principal before the end of the promotional period, you would need to make a payment of about $834 per month for six months ($5,000 6 = $833.33). If you paid back $834 the first month, your principal would decrease to $4,166. After your second payment, your principal would decrease to $3,332, and so on.

Interest

However, most loans don’t offer interest-free terms. When you add in the cost of interest, calculating the repayment on a loan is a bit more complex. But before we look at how interest rates are calculated, we need to define two important terms:

• Interest rate: The amount of interest that is due per repayment period, expressed as a percentage of the principal that you borrow
• Annual percentage rate (APR): While similar to the interest rate, the APR includes the interest rate as well as other costs associated with your loan, such as fees and closing costs; therefore, the APR can be considered your effective rate of interest since it includes the full cost of borrowing the principal. 

To see how interest rates are calculated, consider the following example. Brett is considering different loan amounts that will all be paid over a period of 12 months with an interest rate of 5%. As the principal amount increases, the amount of interest he pays increases as well.

• $1,000 principal: If Brett takes out a loan for $1,000 at a 5% interest rate, he would pay a total of $27.29 in interest over the life of the loan.
• $5,000 principal: If Brett increases the principal to $5,000 at a 5% interest rate, he would pay a total of $136.45 in interest. 
• $10,000 principal: If Brett increases the principal to $10,000 at a 5% interest rate, he would pay a total of $272.90 in interest. 

Let’s see how this plays out when the interest rate changes. Imagine Brett is taking out a $10,000 personal loan. He will pay the loan back monthly over a three-year period. In the table below, you can see that as the interest rate increases, both the monthly payment and the total amount of interest paid increase as well. Notice that while the monthly payment doesn’t increase too significantly, the total interest paid is considerably higher.

Loan Term/Repayment Period

The loan term, also known as the repayment period, is the duration over which the loan is repaid. As with interest rates, the loan term can affect the overall cost of borrowing the money. It’s important to consider how different repayment terms can affect both the payment amount and the amount of interest you’ll pay in total. 

In general, a longer loan term lowers your monthly payment but increases the amount of interest you’ll pay over the life of the loan. A shorter loan term typically means higher monthly payments but lowers the amount you pay in interest. 

For example, imagine Emily takes out a $40,000 personal loan with an 8% interest rate (different loan terms may result in different interest rates, but we’ll imagine that the interest rate does not change for the purposes of this example). In the table below, you can see how a longer loan term lowers the monthly payment but increases the amount of interest paid over the life of the loan.

The type of loan you take out determines how the loan is repaid. Three common types of loans include the following:

• Fixed-rate loans
• Variable-rate loans
• Interest-only loans

Fixed-Rate Loans

Fixed-rate loans are assigned an interest rate that does not change over the life of the loan. When you take out a fixed-rate loan, you can reliably calculate the total amount you’ll pay in interest. You can also rely on the fact that your monthly payment will not change. 

For example, imagine you take out a personal loan for $15,000 at a fixed interest rate of 7%. For a loan term of 60 months, the principal and interest would amount to a monthly payment of $297.

Variable-Rate Loans

A variable-rate loan, on the other hand, means the interest rate can change during an adjustment period based on an underlying benchmark or index, such as the federal funds rate. The interest rate may also include what is known as the margin, which is the additional interest the lender adds on. Your total interest rate would include the index plus the margin. With a variable-rate loan, it becomes more difficult to predict how much your monthly payment might fluctuate over the life of the loan. 

To understand how variable-rate loan repayment works, consider the following example. Zach takes out a 30-year adjustable-rate mortgage (ARM) of $300,000 at an initial interest rate of 3.5%. Let’s say that Zach’s mortgage is a 10/1 ARM, meaning that the interest rate is fixed for the first 10 years, after which it is subject to change annually.

For the first 10 years, the mortgage payment is fixed at $1,347.13 per month. In the 11th year, the interest rate adjusts upward by 0.25%, so now the payment is $1,377.17. In the 12th year, the interest rate adjusts upward by an additional 0.25%, so the payment is now $1,406.26. To see how continual upward adjustments might play out over the remainder of the loan term, view the table below.

Interest-Only Loans

Both fixed-rate and variable-rate loans combine both interest and principal in the monthly payments. An interest-only loan, on the other hand, is a loan that only requires you to pay interest on the principal for a fixed period. You’ll eventually have to pay back the principal, either as a lump sum or through higher monthly payments.

Calculating the payments on an interest-only loan is relatively simple. During the interest-only period, you can simply multiply the loan principal by the interest rate to find out how much your payments will be per year. To see how this works, consider the following example:

Hannah takes out a loan for $50,000 with a 5% interest rate. 

$50,000 x 0.05 = $2,500.

Therefore, Hannah would pay $2,500 per year in interest, or $208.33 per month. Once the interest-only period has ended, Hannah can repay this loan in several ways. She has the following options:

• Pay a single lump sum, also known as a balloon payment
• Convert to amortizing payments in which she pays both the interest and principal in a higher monthly payment
• Refinance into a new loan type

While an interest-only loan doesn’t make sense for all situations, interest-only loans can help to free up cash flow or keep costs low in specific circumstances.

A well-structured repayment plan is key to helping you save money on your loan. One of the easiest ways to save money on a loan is to always make timely payments. Create a budget that factors in the amount of your loan payment each month. If you want to make sure you don’t forget to pay your loan, you may be able to set up an automatic payment either through your loan servicer or through your bank account.

Your loan repayment plan should also align with your financial goals. For example, if you’re looking to become debt-free, you might build faster repayment into your plan by paying more toward the principal each month above the minimum payment. Any time you receive extra money — perhaps from a tax refund or a gift — consider allocating a portion of it toward your debt. Below are some additional strategies to help you save money while repaying a loan:

• Pay the loan off early
• Make extra payments
• Limit your borrowing

Pay the Loan Off Early

Paying your loan off early with a single lump sum may help you save money on interest and free up more cash in your budget to be used for savings or other expenses. However, it’s a good idea to check with your lender whether they allow early repayment and will not assess prepayment penalties if you pay the loan off early.

Make Extra Payments

Making extra payments is another way to pay your loan off early. When making extra payments, you should ensure your lender knows to apply the extra payments toward the principal. To see how much you could potentially save in interest by paying off a loan early, let’s consider an example. 

Max took out a $10,000 personal loan with a 36-month repayment period. The interest rate on Max’s loan is 10%, making his minimum monthly payment $322.67. If he only made the minimum payments, the total interest he would pay over the life of the loan would amount to $1,616.12. However, if he applies an extra $100 per month toward the principal, he would reduce his loan term by 10 months and save $432.27 in interest.

Limit Your Borrowing

Finally, one of the best ways to save money on interest is to limit your borrowing as much as possible. The lower the amounts you borrow, the less interest you pay. Before you take out a loan, carefully calculate the repayment costs and only take out exactly what you need.

Calculating repayment on a loan is one of the most important things you can do to determine how comfortably you can afford to borrow a given amount of money. The most important pieces of data to gather when calculating repayment on a loan are the principal, the interest rate and the loan term. 

It’s also important to understand what kind of loan you’re taking out. If you’re taking out a fixed-rate loan, you can be fairly sure of what your payments will be over the life of the loan. If you’re taking out a variable-rate loan, your payments may be less predictable. And if you’re taking out an interest-free loan, make sure you create a plan to pay back the principal.

Ultimately, understanding loan repayments empowers borrowers to make informed decisions when applying for and comparing loans. The next time you need to take out a loan, use the tools or calculators provided above to consider different scenarios in terms of your interest rates and loan term options so you can confidently manage your loan repayments.

Editor’s Note: Before making significant financial decisions, consider reviewing your options with someone you trust, such as a financial adviser, credit counselor or financial professional, since every person’s situation and needs are different.