Interest is the price you pay in percentage form to borrow money from a lender. As you pay back your principal balance each month, you also have to pay back interest, which does add to the overall cost of your loan. There are two primary types of interest, and it's important to know the difference between the two when it comes to calculating your rate.
Simple interest
Simple interest is the easier of the two to calculate and short-terms loans tend to have simple interest rates. To calculate the total interest you will pay over the life of your loan multiply the principal amount by the interest rate and the lending term in years.
Amortized interest
Amortized loans tend to be more complicated. The initial payments for amortized loans are typically interest-heavy, which means that more of the payments are going toward interest than the principal loan balance. As you get closer to the end of your repayment term, more of your monthly payments go toward the principal balance and less toward interest. To calculate the amortized rate, complete the following steps:
- Divide your interest rate by the number of payments you make per year
- Multiply that number by the remaining loan balance to find out how much you will pay in interest that month.
- Subtract that interest from your fixed monthly payment to see how much of the principal amount you will pay in the first month.
- For the following month, repeat the process with your new loan balance.
Mortgages, auto loans, student loans and personal loans are typically amortized loans.
Factors that affect how much interest you pay
There are several things that impact the interest rate you are eligible for as well as the overall interest you end up paying on an installment loan:
- Credit score. The better your credit, the more likely you are to qualify for a lender’s lowest interest rates. Your credit score indicates to lenders how likely you are to pay back a loan. If you have bad credit, you are likely to receive a higher interest rate so that the lender can make sure it makes its money back even if you default on the loan.
- Debt-to-income ratio. If you have a high amount of monthly debt compared to your income a lender is likely to assign you a higher interest rate. If you currently have several high interest loans, it could be worth looking into debt consolidation in order to lower your monthly payment and simplify your bills.
- Loan amount. The more money you borrow, the higher your interest rate will be. When you take out a large loan, the lender is taking on more risk than if you were to take out a smaller loan. To cut down on interest, make sure you only borrow what you need.
- Loan term. Shorter loan terms come with higher monthly payments, but you end up paying less interest overall. Longer repayment terms come with lower monthly payments, but you end up paying more in interest.
- Type of loan. Loans can either be secured or unsecured. Secured loans tend to have lower interest rates because they are backed by collateral. However, that does mean that you risk losing an asset such as your home or car if you fail to pay back the loan.Personal loans are typically unsecured, meaning that they tend to have higher interest rates than secured loans.
How inflation affects interest rates
The higher the rate of inflation, the higher interest rates will typically trend. Similarly, if inflation is slowing, interest rates tend to drop, too. This is in part because banks anticipate the decreased purchasing power of the interest earned during periods of high inflation.
To get the lowest possible interest rate on your loan, compare top lenders before you apply. If possible, prequalify with a few lenders to see what terms you are eligible for without making a commitment or undergoing multiple hard credit checks within a short period of time.
FAQs
Divide your interest rate by the number of payments you'll make that year. If you have a 6 percent interest rate and you make monthly payments, you would divide 0.06 by 12 to get 0.005. Multiply that number by your remaining loan balance to find out how much you'll pay in interest that month.
What is 6% interest on a $30,000 loan? ›
For example, the interest on a $30,000, 36-month loan at 6% is $2,856.
What is the formula to calculate loan interest? ›
To calculate interest rates, use the formula: Interest = Principal × Rate × Tenure. This equation helps determine the interest rate on investments or loans. What are the advantages of using a loan interest rate calculator?
What is the easiest way to calculate interest? ›
How to Calculate Simple Interest? Simple Interest is calculated using the following formula: SI = P × R × T, where P = Principal, R = Rate of Interest, and T = Time period. Here, the rate is given in percentage (r%) is written as r/100.
How do you calculate real interest on a loan? ›
A “real interest rate” is an interest rate that has been adjusted for inflation. To calculate a real interest rate, you subtract the inflation rate from the nominal interest rate. In mathematical terms we would phrase it this way: The real interest rate equals the nominal interest rate minus the inflation rate.
How much would a $3,000 loan cost per month? ›
The monthly payment on a $3,000 personal loan will depend on the loan term and the interest rate. For example, the monthly payment on a two-year $3,000 loan with an annual percentage rate (APR) of 12% would be $141.22. The monthly payment on a $3,000 loan with a six-year term and an APR of 12% would be $58.65.
Is 7% interest rate high for a loan? ›
A good interest rate on a personal loan is generally on the low end of the range, which currently starts around 7 percent. For example, if you have excellent credit, a rate below 11 percent would be considered good, while 12.5 percent would be less competitive.
How to calculate simple interest on a loan? ›
The formula to determine simple interest is an easy one. Just multiply the loan's principal amount by the annual interest rate by the term of the loan in years. This type of interest usually applies to automobile loans or short-term loans, although some mortgages use this calculation method.
How much is 5% interest on $50,000? ›
5% APY: With a 5% CD or high-yield savings account, your $50,000 will accumulate $2,500 in interest in one year.
What is the formula for borrowing interest? ›
Interest on a loan, such as a car, personal or home loan, is usually calculated daily based on the unpaid balance. This typically involves multiplying your loan balance by your interest rate and then dividing this amount by 365 days (a regular year).
To calculate the weighted average interest rate of all your loans, multiply each loan amount by its interest rate. Add the results together, then divide that number by the sum of all your loan balances.
What is the most basic method of calculating interest? ›
Simple Interest Formula
- Use the formula Interest = P x R x T, where P is the principal, R is the interest rate, and T is the term of the loan.
- For example, to find the interest of a $2,000 loan that has a 0.015 interest rate and 1-year loan term, the formula would look like Interest = 2,000 x 0.015 x 1, which equals 30.
The amount you owe in principal doesn't change during this period, so your monthly payments are lower than they would be with a traditional, amortized loan. To calculate interest-only loan payments, multiply the loan balance by the annual interest rate, and divide it by the number of payments in a year.
How do you calculate simple interest quickly? ›
The principal amount is Rs 10,000, the rate of interest is 10% and the number of years is six. You can calculate the simple interest as: A = 10,000 (1+0.1*6) = Rs 16,000. Interest = A – P = 16000 – 10000 = Rs 6,000.
How to calculate 8% interest on a loan? ›
Then, multiply the principal by the loan's interest rate. If you're calculating the interest on a $10,000 loan borrowed at 8 percent, multiply 10,000 by the previously calculated figure, 0.08. The result is $800.
What is the formula for interest? ›
The formula for calculating simple interest is: Interest = P * R * T. P = Principal amount (the beginning balance). R = Interest rate (usually per year, expressed as a decimal). T = Number of time periods (generally one-year time periods).
What is the formula for simple interest? ›
The formula for simple interest is SI = P × R × T / 100, where SI = simple interest, P = principal amount, R = the interest rate per annum, and T = the time in years.
