How to Calculate a Loan Payment

In order to calculate a loan payment, you will need to know the following: the loan limit, the loan term, the interest rate and how it is calculated. For example, you may know your interest rate, but few mortgages use simple interest. Gather all of these items first, and then use the following calculation to determine how much you will owe each month.

Determining Interest Rate per Term

The hardest part of this equation is determining your interest per term. It is found using a complicated formula:

Rate + [Rate/([(1 + rate)^number of months]-1)]

This seems tricky, but it can be factored down slowly. Let's use an example: You have a 8 percent interest rate on a 30 year mortgage.

  • Start by stating your interest as an annual percentage rate. To do this, divide it by 1200 (100 per month). For 8 percent, the APR is .00666.
  • Add 1 to this number, and you get 1.00666
  • Determine how many payments are on your loan. In a 30 year mortgage, there are 30 X 12 payments, or 360.
  • Compute 1.00666 to the 360th power. The result is 10.936.
  • Subtract 1, and you get 9.936
  • Divide your original APR of .00666 by 9.936
  • You get an answer of .000671
  • Add this to your initial interest rate, and you get the sum .00734
  • This is your realized interest rate. You can plug this into the main formula in the step below. 

Determining Monthly Payment

Now, you can simply use the realized interest rate of .00734 in the main formula. Multiply this by your principal loan sum. In this example, we will imagine your principal is $250,000. This means you will have a monthly payment of $1,835 to pay off your loan in the standard 30 year time frame. You will end up paying $660,000 to pay off the loan once you have accounted for the effect of interest.

Reduce Your Loan Cost

If you want to reduce the cost of your loan, try a scenario where you pay your loan off faster. Use the same formula above, but instead of plugging in 360 months for the loan term, try using only 180 months, the equivalent of a 15-year loan. In this scenario, your APR ends up being much closer to your original interest rate since the interest compounds less frequently. The result is a monthly payment of $2,165. This sounds higher, but the total cost of the loan is $389,700. You have nearly cut your total cost in half by shortening the length of time you plan to pay it off in.

The Easier Route

While it is helpful to understand how interest rates can affect your loan, these calculations can become complicated. If you would like a simpler way to determine your annual payment, ask your lender to quote your interest in APR. You can also use a financial calculator to determine how much you will pay each month. With a financial calculator, you can easily see how differing the length of your loan or paying down points will greatly reduce your cost.

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