Loan Payment Calculations

Understand your Loan Payment and Costs

Calculator and energy bill
Richard Goerg/Photographer's Choice RF/Getty Images

When most people borrow money, the monthly payment is one of their top concerns: is it affordable, given other monthly expenses (and your income)? If you’re not sure how much you’ll need to pay, a loan calculator – or a bit of math – can help you find the answer you need.

Calculators are great for getting a quick answer. They also make it easy to do what-if calculations, which help you truly understand your loan and how your decisions affect your finances.

For example, it’s easy to make multiple comparisons on what happens if you borrow slightly less, or what happens when you get a lower interest rate.

Different Loans, Different Calculations

Before you start calculating payments, you’ll need to know what type of loan you’re using. You’ll use a different calculation (or calculator) for different loans. Some loans are interest-only loans, where you don’t pay off the loan - you only 'service' it by paying interest. Other loans are amortizing loans, where you pay down the loan balance over a set period of time (such as a five-year auto loan).

If you don’t want to do loan payment calculations manually, online calculators can do the math for you.

You can also use spreadsheets such as Google Sheets and Microsoft Excel to do the calculations and show you how the loan works year-by-year. See more details about using a spreadsheet for standard amortizing loans (like auto loans, home loans, and personal loans).

Anytime you calculate your loan payment and costs, you should consider the results a rough estimate. The final details might be different depending on the assumptions your lender uses – but you’ll still get valuable information.

Formula for Amortizing Loan Payment

The formula below works for most amortizing loans (standard auto and home loans, for example).

Loan Payment = Amount / Discount Factor
or
P = A / D

You’ll need the following values:

  • Number of Periodic Payments (n) = Payments per year times number of years
  • Periodic Interest Rate (i) = Annual rate divided by number of payments per
  • Discount Factor (D) = {[(1 + i) ^n] - 1} / [i(1 + i)^n]

Sample Loan Payment Calculation

Assume you borrow $100,000 at 6% for 30 years to be repaid monthly. What is the monthly payment?

  • n = 360 (30 years times 12 monthly payments per year)
  • i = .005 (6% annually expressed as .06, divided by 12 monthly payments per year - learn how to convert percentages to decimal format)
  • D = 166.7916 ({[(1+.005)^360] - 1} / [.005(1+.005)^360])
  • P = A / D = 100,000 / 166.7916 = 599.55

Interest Only Loan Payment Calculation Formula

The loan payment calculation for an interest only loan is easier. Multiply the amount you borrow by the annual interest rate. Then divide by the number of payments per year.

Example (using the same loan as above): $100,000 times .06 = $6,000 per year of interest.

6000 divided by 12 equals $500 monthly payments. Assuming you never pay down any of the principal balance, your monthly payment will remain the same going forward. However, you will have to pay off that loan someday – the loan will probably start to require amortizing payments (perhaps after 10 years), or you’ll need to make a balloon payment at some point to get rid of the debt.

Credit Card Payment Calculations

Credit cards are also fairly simple: there’s often a formula for figuring out what your minimum monthly payment should be. For example, your card issuer might require that you pay at least 3% of your outstanding balance each month (with a minimum of $25 or so). Of course, it’s wise to pay more than the minimum, but that’s the amount you have to pay to stay out of trouble.

Example: assume you owe $7,000 on your credit card. Your minimum payment is calculated as 3% of your balance:

  • Payment = MinRequired x Balance
  • Payment = .03 x $7,000
  • Payment = $210

But what happens the following month? Your credit card charges interest each month, and you might spend more with your card after you make a payment. In many cases, the same minimum applies: a percentage of your total loan balance is due.

For more details, see a tutorial on calculating your card payments and how each payment affects your balance.

Other Important Factors: Interest and Total Loan Cost

Your monthly payment is important – if you don’t have the cash flow, you certainly can’t afford to buy. But the payment doesn’t need to be the most important part of any deal. It’s often more important to focus on:

  • The purchase price, and
  • The amount you’ll pay in interest over the life of your loan

Those two components combined make up the total cost of whatever you're buying.

Your monthly payment is really just a result of the loan amount, interest rate, and length of your loan. Salespeople (including lenders) can shift things around to make it seem like you’re getting a good deal – even when you’re not.

For example, auto dealers often focus on the monthly payment: how much can you comfortably afford each month? With that information, they can sell you almost anything and fit it in your monthly budget. But you aren’t necessarily getting a good deal, and the cost of your loan will dramatically increase the total amount you end up paying for your car.

How do they do it? One of the easiest ways is to stretch out the loan over a few more years: instead of a four or five-year loan (which makes sense), they’ll propose a seven-year loan with lower monthly payments. Unfortunately, stretching out the loan means you’ll pay more in interest over the life of the loan – effectively paying more for whatever you bought.

You’ll almost certainly do better if you negotiate on the purchase price, instead of negotiating on the monthly payment. You can borrow anywhere you want: from any bank, credit union, or online lender – you don’t need to depend on the dealer for financing. You won’t always get a lower monthly payment this way (so it might not feel like you’re doing better), but you’ll probably spend less overall.

To further minimize your costs, pay off your debt early. As long as there's no prepayment penalty, you can save on interest by paying extra each month or by making a large lump-sum payment. Depending on your loan, your required monthly payments going forward might or might ​not change – ask your lender before you pay.

Learn more about paying off debt early.

Continue Reading...