If you get approved for a loan, your lender will usually provide you with all the details on how to pay it back. That includes how much you have to pay and when. But understanding how to calculate monthly loan payments can be helpful and important.
Find out why below and learn how to do some basic loan repayment calculations.
Why learn how to calculate monthly loan payments?
Knowing how to calculate potential monthly loan payments can be a good tool when shopping for a loan. By doing these calculations, you can better understand the actual costs of loans for comparison.
This information can also help you make a decision about whether or not a specific type of loan might be a good idea.
For example, you may have a budget and know that you can only afford a $200 loan per month. If you run the calculations and find that the monthly loan payment would be $300, you know that loan is not right for you at this time.
Step-by-Step Guide to Calculating a Monthly Loan Payment
Follow these steps to learn how to calculate a rough estimate of your monthly loan payments. You’ll want a calculator handy to do some calculations; the option on your computer or smart phone will work.
Step 1: Understand the types of loans.
The formula for calculating loan payments varies depending on the type of loan you’re dealing with.
An amortized loan is calculated so that you pay more interest and less principal at the beginning of a loan repayment plan. Over time, more and more of your monthly payments go to principal and less to interest. This is common with auto and home loans.
You can also have an interest-only loan. With this type of loan, all of your payments go to interest at first. You only begin repaying the principal you borrowed once the interest is fully paid.
The formulas for calculating monthly payments for this type of loan differ. For the purposes of this guide, you will learn how to calculate amortized loan payments.
Step 2: Understand the terms.
To calculate monthly loan payments, you will need to know three things:
The total amount borrowed (a)
The interest rate expressed as a decimal divided by 12 months per year (r)
The total number of months you will make loan payments (n).
There is a possibility that you are not yet aware of all of these facts. You may know that you want to borrow $5,000 and would like to pay it back in 3 years. You would then have to do some research to find out what various lenders were charging in terms of interest rates so that you could estimate a monthly payment.
Step 3: Know the formula for calculating monthly payments and do the math.
Once you have all the information, enter it into the following formula:
a x [r(1+r)^n / (1+r)^n)-1].
It is to take into consideration that the use of the ^ sign refers to the expression of, the power of.
That’s a lot of math, so let’s look at a hypothetical example.
Imagine someone borrows $5,000 for 3 years at a rate of 9%.
a = the total amount borrowed. In this case, it is $5,000.
r = the monthly interest rate expressed in decimal form.
To get that, divide the percentage by 100 and then again by 12. In this case, it would be 0.0075.
n = the total number of months in which you will make payments. In this case, it is more than 3 years. Multiple 3 years by 12 months to get 36.
Start with half of the formula: r(1+r)^n. Plugging in our numbers, the math works like this:
Next, work out the last part of the formula: [(1+r)^n]-1. Plugging in our numbers, that math works like this:
Now insert those numbers into the formula: a (multiplied by) [(1+r)^n]-1 (divided by) r(1+r)^n.
The estimated monthly payment is $158.50.
The easiest way to calculate monthly payments on a loan.
That’s a lot of math and a lot of places to make an arithmetic error. So, if you don’t feel like using the scientific calculator on your computer, don’t worry. There’s a much easier way to calculate monthly loan payments.
The Internet is full of loan calculators that will do these calculations for you. All you have to do is enter the interest, the amount of the loan, and the total time you will pay for the loan.
You should make sure that the online loan calculator you are using is for the type of loan and interest you are researching. Other than that, these tools are usually very simple and take seconds to use.
How to lower your monthly loan payments
There are a few ways to lower your monthly loan payment on a potential loan. They include:
Borrowing longer. The more months you have to repay a loan, the less you will have to pay each month.
Borrowing less. Obviously, the less you borrow over the same period of time, the less you will pay each month.
Get a better interest rate. The higher your interest rate, the better your interest rate.