How to Calculate Interest Rate on a Loan

When you take out a loan, it can feel good to cover your expenses at the time, but unless you understand what you’re getting yourself into, that can quickly put you in a tight spot. Whether you’re thinking of taking out a loan or you’ve already done that, researching your loan’s cost is essential, with that cost being the interest rate. Learn how do loans work here.

Expressed in a percentage of the original amount or principal, the interest rate could be considered the fee you pay to use another entity’s money or to take out a loan, whether that’s a car loan, a personal loan, or a credit card. For banks and lenders, interest is what makes the risk they take when they lend you money worth it. Discover how to calculate loan here.

Consequently, when you make your repayments, you’re not only reducing the balance but also covering the interest on it. Therefore, you must know how to calculate the interest rate on loans, and we’re determined to show you just how.

How to Calculate Interest Rate on a Loan: Simple vs. Amortizing Loan

Typically, you won’t have to sweat to find out the interest rate because you can get that information from your loan offer, but you might, however, want to calculate your interest. If you can’t get a loan because “need loans been refused everywhere“, consider applying today at Perfect Payday.

In that case, there are two distinct formulas for each of these two main types: simple and amortizing loans. Learn how long will it take to pay off my loan here.

Spreadsheets are helpful in that, as you can use Microsoft Excel or Google Sheets, for example, to build a model of your loan, and create a table of four columns: interest rate, the total number of years, loan balance/principal, and monthly payment. Furthermore, Excel has built-in functions for amortization formulas. Find out how to get approved for a personal loan here.

Afterwards, you can use an online loan approval process amortization calculator by clicking here or here if math isn’t your strongest suit or if you want to double-check. But, if you’re going to do it the old-fashioned way, we’ll break down the simple and amortizing loan formulas for you.

Simple Loan

how to work out interest on a loan

With simple interest, interest is expressed as a percentage of the principal alone, and the following steps will guide you on how to work out interest on a loan for simple loans. Learn what happens when you default on a loan here.

Steps:

  1. You need to figure out the principal loan amount, interest rate, and the number of months/years you’ll be pay the multiple payday loan.
  2. Calculate your total interest where:

Total Interest = Principal Loan Amount x Interest Rate x Time

Example:

  1. Principal Loan Amount = $100, Interest Rate = .06, Number of Years = 1
  2. Total Interest = $100 x .06 x 1 =$6

(Most loans tend to be more complex, but this example was selected for demonstration.)

Amortizing Loans

These include student loans, mortgages, and auto loans. With amortizing loans, your repayments are equal instalments, and at first, they’re mostly composed of interest with little money going to the principal loan amount. Then, as your loan comes to an end, your repayments mostly go to the principal balance with little money going to interest. Learn the definition of loan here.

As previously mentioned, this formula is quite different, so without further ado, this is how to calculate interest on the loan per month for an amortizing loan.

how to calculate interest on loan per month

Steps:

  1. Figure out the remaining loan balance for that month, the interest rate, and the number of payments per year. Learn how to pay off loan here.
  2. Interest (for the first month) = (Interest Rate / Number of Payments Per Year) x Remaining Loan Balance
  3. Paid Principal (for the first month) = Fixed Monthly Payment – Interest
  4. New Balance = Total Principal – Paid Principal

Tip: You can repeat this process with each month’s new remaining loan balance to find the interest and principal for it.

Example:

  1. Remaining Loan Balance = $100,000, Interest Rate = 6%, Number of Payments Per Year = 12, Fixed Monthly Payment = $599.55
  2. Interest (for the first month) = (6% / 12) x $100,000 = $500
  3. Paid Principal = 599.55 – 500 = $99.55
  4. New Balance = 100,000 – 99.55 = $99,900.45

What Factors Contribute to Interest?

Since we’ve illustrated the formulas that denote how to work out interest on a loan, it’s only appropriate that we address the variables or factors that affect the interest’s formula. Learn what is a payday loan here.

1. Interest Rate

Interest rate is a game-changer when it comes to interest, but it’s essential to understand the distinction between the interest rate and loan fees/charges. When combined, you get the comparison rate.

A home loan’s interest rate can be variable so that it may change according to factors, like Reverse Bank cash rate. Others have a fixed rate throughout the loan duration, and some even have part-fixed-part-variable interest payments.

2. Loan Amount

Needless to say, the bigger your loan is, the higher the interest.

3. Loan Term

As the loan term stretches out more, the interest you pay accumulates more, so paying above the minimum for a month helps shorten the loan duration and automatically reduces the interest you have to pay.

4. Repayment Frequency

how does interest work on a loan

Again, because interest increases with time and is calculated daily, weekly instalments entail less interest than monthly instalments. For the same reason, your interest in a 31-day month will be higher than that for a 29-day month. What if you’re young? Learn about loans for 17 year old here.

Conclusion

Ultimately, we hope you know how interest works on a loan. It’s as simple as determining whether this loan is simple or amortizing, figuring out the principal loan amount, interest rate, number of months/years you’re paying the loan, and such information that you’ll find in the loan offer. Learn what a loan with a paid default is here.

Then, you can always revert to spreadsheets and online loan amortization calculators for help, or you can simply apply those numbers to the corresponding formula for your loan type, and voila! This is how to calculate interest on a loan. Learn the difference between secured loan vs unsecured loan on this page.

About the Author

Lucy has over a decade of experience in finance. She is currently the content curator here at Perfect Payday.

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