How to Calculate Loan Payments (Simple & Amortized)

Understanding how your loan payment is calculated can save you thousands of dollars when borrowing for a house, car, or personal expense.

Lenders use an “amortization formula” to determine your monthly payment. This ensures that you pay off both the interest and the principal over a set period.

In this guide, we’ll explain the math and show you how to use our Free Loan Calculator to run your own numbers.

The Standard Loan Formula

The formula for a fixed-rate loan payment is:

$M = P \frac{r(1+r)^n}{(1+r)^n - 1}$

Where:

• M = Monthly Payment
• P = Principal (Loan Amount)
• r = Monthly Interest Rate (Annual Rate / 12)
• n = Number of Payments (Loan Term in Months)

Example

You borrow $10,000 at 6% interest for 3 years (36 months).

1. r = 0.06 / 12 = 0.005
2. n = 36
3. Numerator: 10,000 * 0.005 * (1.005)^36 ≈ 59.83
4. Denominator: (1.005)^36 - 1 ≈ 0.1967
5. Payment: 59.83 / 0.1967 ≈ $304.22

Understanding Amortization

Your payment of $304.22 stays the same every month, but what’s inside it changes.

• Month 1:

  • Interest: $10,000 * 0.005 = $50.00
  • Principal: $304.22 - $50.00 = $254.22
  • New Balance: $9,745.78

• Month 36 (Last Payment):

  • Interest: ~$1.50
  • Principal: ~$302.72

This is why making extra payments early is so effective. Every extra dollar goes 100% toward principal, skipping the interest cycle entirely.

Different Loan Types

Fixed-Rate vs. Variable-Rate Loans

Fixed-rate loans maintain the same interest rate throughout the loan term. Your monthly payment never changes, making budgeting easier.

Variable-rate loans (also called adjustable-rate) start with a lower initial rate that can increase or decrease based on market conditions. The payment amount changes when the rate adjusts.

Example: A 5/1 ARM (Adjustable-Rate Mortgage) has a fixed rate for 5 years, then adjusts annually. If rates rise, so does your payment.

Interest-Only Loans

With interest-only loans, you pay only the interest for a set period (e.g., 10 years), then start paying principal + interest.

Monthly Payment (Interest-Only): $10,000 loan at 6% = $50/month for the interest-only period.

After the interest-only period ends, you’re suddenly paying principal too, which can double or triple your payment. These loans are risky unless you have a clear repayment strategy.

Balloon Loans

You make small payments for a set period, then owe the entire remaining balance in one lump sum.

Example: $20,000 loan with $200/month payments for 5 years, then a $15,000 balloon payment at the end.

These are dangerous unless you have a guaranteed source of funds (like a bonus or home sale) to cover the balloon.

Common Mistakes to Avoid

Ignoring the APR vs. Interest Rate

The interest rate is what you pay on the loan. The APR (Annual Percentage Rate) includes fees like origination fees, closing costs, and insurance.

Example: A 6% interest rate might have a 6.3% APR once fees are included.

Always compare APRs when shopping for loans, not just interest rates.

Extending the Loan Term to Lower Payments

A 7-year auto loan has lower monthly payments than a 3-year loan, but you’ll pay thousands more in interest.

Example: $20,000 car loan at 5% interest

• 3-year term: $599/month, total interest = $1,562
• 7-year term: $283/month, total interest = $3,761

You save $316/month but pay an extra $2,199 in interest over the life of the loan.

Only Making Minimum Payments

Your lender calculates the minimum payment to ensure the loan is paid off on time. If you only pay the minimum, you pay the maximum interest possible.

Solution: Pay extra toward principal whenever possible. Even $50/month extra can shave years off a mortgage.

Not Shopping Around for Rates

A difference of 0.5% might not sound like much, but on a $300,000 mortgage over 30 years, it’s $30,000 in additional interest.

Example: $300,000 at 6.5% vs. 6.0%

• 6.5%: $1,896/month, total interest = $382,633
• 6.0%: $1,799/month, total interest = $347,515

That’s $35,118 saved by shopping for a better rate.

Confusing Pre-Qualification with Pre-Approval

Pre-qualification: A rough estimate based on self-reported income. Not binding.

Pre-approval: The lender verifies your income, credit, and assets. This is a real commitment (subject to final underwriting).

When house hunting, pre-approval gives you negotiating power. Sellers treat pre-approved offers more seriously.

Pro Tips

Bi-Weekly Payments Hack

Instead of paying monthly, pay half your monthly payment every two weeks. You’ll make 26 half-payments (13 full payments) per year instead of 12.

Example: $1,200/month = $14,400/year Bi-weekly: $600 every 2 weeks × 26 = $15,600/year

That extra $1,200/year goes 100% toward principal, potentially cutting years off your loan.

Refinancing When Rates Drop

If interest rates fall by 1% or more, refinancing can save thousands.

Example: You owe $200,000 at 7% with 20 years left. Rates drop to 5%. Refinancing saves you $300/month.

Caution: Refinancing resets the clock. If you have 10 years left and refinance into a 30-year loan, you’ll pay more total interest despite the lower rate.

Round Up Your Payments

If your payment is $1,342, round it up to $1,400. That extra $58/month goes straight to principal.

Over a 30-year mortgage, rounding up can save tens of thousands in interest and cut 2-3 years off the loan.

Avoid Private Mortgage Insurance (PMI)

PMI is required on mortgages with less than 20% down. It costs 0.5%-1% of the loan annually and doesn’t benefit you. It protects the lender.

Solution: Save for a 20% down payment or request PMI removal once you reach 20% equity.

Use the 28/36 Rule

Lenders use the 28/36 rule to determine how much you can afford:

• 28%: Your housing payment (principal, interest, taxes, insurance) shouldn’t exceed 28% of gross monthly income.
• 36%: Total debt payments (housing + car + student loans + credit cards) shouldn’t exceed 36%.

Example: $5,000/month gross income

• Max housing: $1,400/month
• Max total debt: $1,800/month

Staying within these limits ensures you don’t become house-poor.

Real-World Scenarios

First-Time Home Buyer

You’re buying a $350,000 home with 10% down ($35,000). You borrow $315,000 at 6.5% for 30 years.

Monthly Payment: $1,991 (principal + interest only)

Total Interest Paid: $401,773 (more than the original loan!)

Strategy: If you pay an extra $200/month, you’ll save $85,000 in interest and pay off the loan 7 years early.

Auto Loan Decision

You’re financing a $30,000 car. Dealer offers 0% for 48 months or $3,000 cash rebate + 4% financing.

Option 1 (0%): $625/month × 48 = $30,000 total

Option 2 ($3,000 rebate + 4%): Borrow $27,000 at 4% for 48 months = $610/month, total = $29,280

Winner: Take the rebate. You save $720.

Student Loan Repayment

You owe $50,000 at 5% with a 10-year standard repayment plan.

Monthly Payment: $530

Total Interest: $13,639

If you get a $10,000 bonus and apply it to principal immediately, you’ll save $4,200 in interest and pay off the loan 2 years early.

Frequently Asked Questions

Can I pay off my loan early without penalty?

Most personal and auto loans allow early payoff with no penalty. However, some mortgages have prepayment penalties (typically 2-3% of the balance if paid off within the first 3-5 years). Check your loan agreement before making lump-sum payments.

Should I pay off my loan or invest extra money?

It depends on the interest rate. If your loan is 7% and you can earn 10% in the stock market, investing makes mathematical sense. But paying off debt is guaranteed savings, while investment returns are not. Many financial advisors recommend paying off high-interest debt (above 6-7%) before investing beyond employer-matched retirement contributions.

What happens if I miss a payment?

Missing one payment typically results in a late fee ($25-$50) and a ding on your credit report if more than 30 days late. Missing multiple payments can lead to default and repossession (for secured loans like cars or homes). Contact your lender immediately if you anticipate difficulty making a payment, as many offer hardship programs.

How is interest calculated on credit cards compared to loans?

Credit cards use daily compounding, making them more expensive than loans with monthly compounding. A 20% APR credit card actually costs about 22% annually due to compounding. This is why carrying a credit card balance is far more expensive than a personal loan at the same stated rate.

Can I negotiate my interest rate?

Sometimes. If you have excellent credit (750+), you can ask lenders to match a competitor’s rate. For mortgages, paying “points” (1 point = 1% of loan amount) can lower your rate by 0.25%. Always get quotes from at least three lenders to strengthen your negotiating position.

Use the Calculator

You don’t need a spreadsheet to track this. Our Loan Calculator generates a full amortization schedule instantly, showing you exactly how much interest you’ll save by paying extra. Enter different scenarios (extra payments, shorter terms, lower rates) to see the impact on your total cost. It also calculates total interest paid, payoff date, and monthly breakdowns of principal vs. interest.