If you get approved for a loan, your lender will typically provide you with all the details on how to pay it back. That includes how much you need to pay and when. But understanding how to calculate monthly payments for loans can be useful and important. Find out why below and learn how to do some basic loan payment calculations.
Why Learn to Calculate Monthly Payments for Loans?
Knowing how to calculate potential monthly loan payments can be a good tool when you’re shopping around for or researching for a loan. By making these calculations, you can better understand the real costs of loans to compare them.
This information can also help you make a decision about whether a specific type of loan might be a good idea or not. For example, you may have a budget and know you can only afford to make a loan payment of $200 a month. If you run calculations and find the monthly loan payment would be $300, you know that loan isn’t 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 monthly loan payments. You’ll want a calculator handy for doing some math; the option on your computer or smartphone will work.
Step 1: Understand loan types.
The formula for calculating loan payments varies depending on the type of loan you’re dealing with.
An amortized loan is calculated so you pay more interest and less principal at the outset of a loan repayment plan. Over time, more and more of your monthly payments go toward the principal and less toward interest. This is common with car and home loans.
You can also have an interest-only loan. With this type of loan, all your payments go toward interest at first. You only start paying down the principal you borrowed once the interest is completely paid.
The formulas for calculating monthly payments on these types of loans differ. For the purpose of this guide, you’ll be learning how to calculate payments on amortized loans.
Step 2: Understand the terms.
To calculate monthly loan payments, you’ll 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 payments on the loan (n)
Depending on where you are in this process, you may not know all of these things. Perhaps you know you want to borrow $5,000, and you’d like to pay it off in 3 years. You would then have to do your research to find out what various lenders were charging when it comes to interest rates to be able to estimate a monthly payment.
Step 3: Know the formula for calculating monthly payments and do the math.
Once you have all the information, you plug it into the formula below:
a (multiplied by) [r(1+r)^n (divided by) (1+r)^n)-1]
Note that ^ means “to the power of.”
That’s a lot of math, so we’ll walk through a hypothetical example. Imagine someone borrows $5,000 for 3 years at a rate of 9%.
- a = the total amount borrowed. In this case, that’s $5,000.
- r = the monthly interest rate expressed in decimal form. To get that, you divide the percentage by 100 and then again by 12. In this case, it would be 0.0075
- n = the total months you’ll make payments. In this case, it’s more than 3 years. Multiple 3 years by 12 months to get 36.
Start with the middle of the formula: r(1+r)^n. Plugging in our numbers, the math works like this:
Next work on the last part of the formula: [(1+r)^n]-1. Plugging in our numbers, that math works like this:
Now plug those numbers into the formula: a (multiplied by) [(1+r)^n]-1 (divided by) r(1+r)^n.
- Estimated monthly payment is $158.50
The Easier Way to Calculate Monthly Loan Payments
That’s a lot of math and plenty of places to make an arithmetic mistake. So, if you’re not on a first-name basis with orders of operations or don’t feel like whipping out the scientific calculator on your computer, don’t worry. There’s a much easier way to calculate monthly loan payments.
The internet is filled with loan calculators that will do this math for you. All you have to do is enter in the interest, loan amount and total time you’ll be paying on the loan. You do want to make sure the online loan calculator you’re using is for the type of loan and interest you’re researching. Aside from that, these tools are usually a breeze and take mere seconds to use.
How to Reduce Your Monthly Loan Payments
There are a few ways to reduce the monthly loan payment on a potential loan. They include:
- Borrowing for longer. The more months you have to pay back a loan, the less you have to pay every month.
- Borrowing less. Obviously, the less you borrow over the same period of time, the less you’ll be paying back each month.
- Get a better interest rate. The higher your interest rate, the costlier the overall loan. That also drives up your monthly payment amount. If you have good enough credit, consider shopping around for lower interest rates to save money on a loan. If you don’t already have good credit, consider whether there are steps you can take to build it before you take out a loan — especially a large one.
A loan from Wise Loan One will help you build credit while getting money you might need. Wise Loan doesn’t require good credit for approval, and it reports to two of the three credit bureaus to help you build your credit if you make payments in a timely manner. Consider applying today.