How to Calculate Loan Payments
Learn the formula for calculating monthly loan payments on any installment loan, including personal loans, auto loans, and student loans.
The Installment Loan Payment Formula
Monthly loan payments are calculated with the same formula used for mortgages: M = P[r(1+r)^n] / [(1+r)^n - 1], where P is the principal, r is the monthly interest rate (annual rate ÷ 12), and n is the number of monthly payments. For a $15,000 auto loan at 6% for 5 years: r = 0.005, n = 60, giving M ≈ $289.99 per month.
Total Interest Paid Over the Loan Life
To find total interest paid, multiply the monthly payment by the number of payments, then subtract the original principal: Total Interest = (M × n) - P. For the auto loan example: ($289.99 × 60) - $15,000 = $2,399.40 in interest over the life of the loan. Choosing a shorter term always reduces total interest paid, though it increases the monthly payment.
Effect of Loan Term on Payments
Extending a loan term reduces the monthly payment but dramatically increases total interest paid. A $20,000 personal loan at 8% costs $405.53/month over 5 years (total interest: $4,331.80) versus $242.66/month over 10 years (total interest: $9,119.20). The longer term costs over twice as much in interest for the convenience of a lower monthly payment.
Simple Interest vs. Compound Interest Loans
Most installment loans (auto, personal, student) use simple daily interest: interest accrues each day on the outstanding principal balance. Unlike compound interest savings accounts, this means interest does not accrue on unpaid interest. Making payments early or more frequently reduces the outstanding principal faster and therefore reduces the total interest that accrues.
Loan Origination Fees and APR
Lenders sometimes charge origination fees (typically 1%–8% of the loan amount) that are either deducted from your proceeds or added to your balance. These fees raise the effective cost of borrowing above the stated interest rate, which is why the APR (Annual Percentage Rate) is a more complete cost measure. Always compare APRs, not just interest rates, when shopping for loans.
Paying Off Loans Early
Most personal and auto loans allow early payoff without penalty, though some lenders charge a prepayment penalty — always check your loan agreement. Paying extra each month applies directly to principal, reducing future interest charges. A $10,000 loan at 7% with a 5-year term can save over $600 in interest by adding just $50 extra per month to each payment.
Using Loans Strategically
Low-interest loans for appreciating assets (education, a reliable vehicle needed for work) can be financially sound. High-interest debt on depreciating assets or consumption should be minimized and repaid aggressively. A debt avalanche strategy — paying the highest-interest debt first — minimizes total interest paid, while a debt snowball strategy — paying the smallest balance first — builds psychological momentum.
Try These Calculators
Put what you learned into practice with these free calculators.
Related Guides
How to Calculate Mortgage Payments
Learn how to calculate mortgage payments step by step. Understand the mortgage payment formula, principal vs. interest breakdown, escrow, PMI, and how to use amortization schedules.
How to Create an Amortization Schedule
Learn how to build a loan amortization schedule step by step, showing how each payment is split between interest and principal over the life of a loan.
How to Calculate APR vs Interest Rate
Understand the difference between APR and interest rate, how APR is calculated to include fees, and why APR is the better metric for comparing loan offers.