How Loan Payments Are Calculated
Most mortgages, car loans and personal loans are amortizing loans: you pay the same amount every month, and each payment is split between interest and principal. Early in the loan, most of your payment goes to interest because the balance is large. As the balance falls, the interest portion shrinks and more of each payment reduces what you owe. The yearly schedule above shows this shift clearly.
The payment formula
P is the amount borrowed, r is the monthly interest rate (APR ÷ 12) and n is the number of monthly payments. This is the same formula lenders use, so the result should match a loan offer to within a few cents, before fees or insurance.
Worked example
Borrowing $25,000 for five years at 7.5% gives a monthly payment of about $501. Over 60 payments you repay roughly $30,060 in total — about $5,060 of it interest. Adding just $100 a month clears the loan around 11 months early and saves about $1,000 in interest.
How the term changes the total cost
| $25,000 at 7.5% | Monthly payment | Total interest |
|---|---|---|
| 3 years | ≈ $778 | ≈ $3,000 |
| 5 years | ≈ $501 | ≈ $5,060 |
| 7 years | ≈ $383 | ≈ $7,210 |
A longer term lowers the monthly payment but increases the total interest you pay. Choosing the shortest term you can comfortably afford is usually the cheapest option overall.
Before you borrow
- Compare APR, not just the rate. The annual percentage rate includes many fees and gives a fairer comparison between lenders.
- Check for prepayment penalties if you plan to make extra payments.
- Keep the payment affordable. A common guideline is to keep total debt payments well below a third of gross income.
- Make extra payments towards principal. Ask the lender to apply extra money to the balance rather than to future payments.
Carrying credit-card balances rather than an installment loan? The debt payoff calculator is built for revolving debt.
Frequently Asked Questions
Does this include taxes, insurance or fees?
No. The payment covers principal and interest only. Mortgages often add property tax, home insurance and mortgage insurance to the monthly bill, and some loans add origination fees.
What is the difference between APR and interest rate?
The interest rate is the cost of borrowing the principal. The APR (annual percentage rate) also folds in many lender fees, so it is usually a little higher and is the better number for comparing offers.
Why does so much of my early payment go to interest?
Interest is charged on the outstanding balance. At the start the balance is highest, so the interest portion is largest. Each payment reduces the balance, so the interest portion falls over time.
Is it better to make extra payments or invest?
It depends on the loan rate versus the return you can reasonably expect, your risk tolerance and whether you have an emergency fund. Paying off a 7% loan is a guaranteed 7% return; many people prioritise high-rate debt first.
Disclaimer: This calculator is for educational purposes only and does not constitute financial, tax or investment advice. Results are estimates based on the assumptions you enter; real returns, rates, fees and taxes vary. Consider speaking with a licensed financial professional before making decisions.
Related tools