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# How to Calculate Loan Interest

• Interest is what it costs to borrow money.
• Many factors affect your interest rate, such as the loan amount and repayment term.
• To use a loan calculator correctly, you must know if your lender uses simple interest or amortized interest.
• Knowing how to make these calculations gives you more power as a borrower.

When you borrow money, your monthly payment includes principal and interest.

Depending on your interest rate and loan amount, you may have to pay back hundreds or even thousands of dollars more than you originally borrowed. That’s why it’s so important to know how to calculate interest on a loan.

We created this guide to help you learn more about interest, including what it is, what types of interest a lender can charge and how to calculate interest on loan balances. Improve your financial situation by learning about how your interest rate affects the total cost of borrowing money.

## What is loan interest?

Loan interest is the price you pay for borrowing money, much like a fee for the convenience of using someone else’s funds.

This enables lenders to earn income while assisting you in financing your needs, whether it’s purchasing a home, a car, or covering other expenses. Typically calculated as a small percentage of the total amount borrowed, the interest rate can either remain fixed or vary over time depending on the loan type.

Lenders employ two types of interest to earn money on borrowed amounts: simple interest and amortized interest. Let’s take a closer look at these two types, as well as differentiate between loan interest rates and APR.

### Simple interest

Simple interest is interest calculated using only the principal amount of the loan. The interest rate never changes, so it’s easy to predict how much you’ll pay with each monthly payment. Lenders use simple interest for short-term personal loans and car loans.

### Amortized interest

Amortized interest means that when you make regular payments on a loan, part of the money goes toward paying off the amount you borrowed (called the principal), and the other part goes toward paying the interest charged on the loan.

As you make these payments, the amount of interest you pay decreases over time because the balance you owe (the principal) gets smaller. This process continues until you’ve paid off both the principal and the interest.

It’s commonly used in mortgage loans and other types of installment loans. It’s less common for short-term loans like payday loans.

### Loan interest vs. annual percentage rate

While both are expressed as percentages, loan interest rate and annual percentage rate (APR) differ significantly.

Your interest rate represents the annual cost of borrowing money, focusing solely on interest charges and excluding origination fees and other costs.

On the other hand, APR encompasses the total yearly cost of borrowing, including interest, broker fees, points, and additional expenses. By factoring in these fees, APR provides a more precise estimate of the overall borrowing expenses.

## How to calculate interest on a loan

Here’s how to calculate simple and amortized interest.

### How to calculate simple interest

The formula to calculate simple interest on a loan is: SI = P × R × T, where P = Principal, R = Rate of interest, and T = Time in years.

For example, assume you have a loan with a \$10,000 principal balance, a 10% interest rate and three-year term. Using the simple interest formula, you’d pay \$3,000 in interest (10,000 x 0.10 x 3).

Try using our calculator below to see how much interest you would owe on a short-term loan.

## Simple Interest Loan Calculator

Total interest paid
0
Total amount paid (principle + interest)
0

Important Note: The figures provided on this platform are meant for general information purposes only and should not be considered financial advice. We strongly encourage you to check with the specific financial institution for an accurate estimate before applying for any financial product.

### How to calculate amortized interest

Calculating amortized interest is a little more complicated.

Here’s how to determine how much interest you’ll pay over time:

2. Divide the result by 12 to determine how much interest you pay each month.
3. Subtract the interest from your monthly payment.
4. Repeat the third step as many times as needed to determine how much interest you’ll pay over the life of the loan.

For example, assume you have a \$20,000 principal balance, an interest rate of 5% and a one-year repayment term.

Here’s an amortization schedule showing how much interest you’d pay:

Payment due date Payment amount Principal Interest Balance
January 2025 \$1,712.15 \$1,628.82 \$83.33 \$18,371.18
February 2025 \$1,712.15 \$1,635.60 \$76.55 \$16,735.58
March 2025 \$1,712.15 \$1,642.42 \$69.73 \$15,093.16
April 2025 \$1,712.15 \$1,649.26 \$62.89 \$13,443.90
May 2025 \$1,712.15 \$1,656.13 \$56.02 \$11,787.77
June 2025 \$1,712.15 \$1,663.03 \$49.12 \$10,124.73
July 2025 \$1,712.15 \$1,669.96 \$42.19 \$8,454.77
August 2025 \$1,712.15 \$1,676.92 \$35.23 \$6,777.85
September 2025 \$1,712.15 \$1,683.91 \$28.24 \$5,093.94
October 2025 \$1,712.15 \$1,690.92 \$21.22 \$3,403.02
November 2025 \$1,712.15 \$1,697.97 \$14.18 \$1,705.05
December 2025 \$1,712.15 \$1,705.05 \$7.10 \$0.00

Now all you have to do is add up the numbers in the interest column to determine the total amount of interest paid. In this scenario, you’d pay \$545.80 in interest.

## What factors impact loan interest rates?

Several factors affect the interest rate on a loan:

• Loan amount: Although lenders make money on loans, they have to spend money to process your application and service the loan until it’s paid in full. If you borrow a small amount of money, the lender may charge you a slightly higher interest rate to cover these costs.
• Your credit score: Your interest rate also depends on your credit score, which is based on the amount of debt you have, your repayment history and other factors. Lenders use these scores to predict your financial behavior. If you have a low score, the lender is likely to charge a higher interest rate.
• Loan term: A loan term is the amount of time you have to pay back the money you borrow. For example, if you have a 36-month loan term, you have three years to pay what you owe. Lenders charge more for long loan terms than they do for short loan terms.
• Repayment schedule: How often you make a payment has an impact on how fast you pay back the money you borrow. If you make monthly payments, for example, it will take you longer to repay the loan than it would if you made weekly payments. The more time between payments, the higher your interest rate. Hardship loans may offer flexible repayment schedules to accommodate your financial situation.

## What is the average interest rate on a loan?

The table below shows the average interest rates for six types of loans.

Loan type Average interest rate (Credit Unions) Average interest rate (Banks)
Home equity loan (5-year term; 80% equity) 7.09% 7.37%
Mortgage (15-year fixed rate) 6.50% 6.65%
Mortgage (30-year fixed rate) 6.90% 7.02%
New car loan (60-month term) 6.40% 7.21%
Unsecured loan (36-month term; fixed interest rate) 10.83% 11.65%
Used car loan (48-month term) 6.27% 7.13%

This data comes from the National Credit Union Administration. Interest rates change frequently, so what you pay today may be different from what you see above. These averages were current as of July 2024.

## How can I get a better interest rate on a loan?

Follow these guidelines to qualify for a lower interest rate on a loan.

If you have a low score, do everything you can to increase it. Depending on your situation, you may have to pay off some of your debt or wait a few months until a negative item “falls off” your credit report. A low credit score might result in being denied a loan, so improving it can also increase your chances of approval.

### Shop around and compare

Don’t accept the first loan offer you get. Another lender may offer a lower rate, so shop around and compare terms to find the best deal.

### Make automatic payments

If you set up automatic payments, your lender may offer a small discount on your interest rate. This reduces your total cost of borrowing.

### Apply for short-term loans

As mentioned previously, longer terms come with higher interest rates. To qualify for a lower rate, try applying for a loan with a shorter term.

Your debt-to-income ratio compares how much debt you have with how much income you earn. If it’s high, you may not qualify for a loan with your preferred lender. Reduce your DTI by paying off some of your debt.

A co-applicant, also known as a co-borrower, is someone who agrees to repay the loan if you default on the payments. If you have a loved one with an excellent credit score, adding them as a cosigner may help you qualify for a better interest rate. Adding a co-applicant can also help you get approved for a loan if you have no credit history.

## How to calculate loan interest FAQs

### What is the formula to calculate loan interest?

To calculate simple interest on a loan, use this formula: SI = P × R × T. In this formula, P = Principal, R = Rate of interest, and T = Time in years.

### Why do interest rates change?

Interest rates fluctuate due to various factors, including the economy’s overall health, government policies, supply and demand for money (how many borrowers seek loans versus how many lenders provide them), loan terms and risk levels, and inflation rates.

### Can I get a low-interest loan with bad credit?

Generally, no. Lenders charge different rates based on your creditworthiness. If your score is low, you’ll pay more for credit than you would if you had a high score. Prequalifying for a loan can help you understand what rates you might be offered based on your credit score.

### What's the difference between principal and interest?

Principal is the original amount of money borrowed, while interest is the cost of borrowing.

### Is it better to pay of interest or principal first?

It’s better to pay off principal first. Lenders charge interest based on the amount of principal remaining, so paying the principal first can help you reduce the total amount of interest you pay.

Leigh Morgan Personal Finance

Leigh Morgan is a seasoned personal finance contributor with over 15 years of experience writing on a diverse range of professional legal and financial topics. She specializes in subjects like navigating the complexities of insurance, savings, zero-based budgeting and emergency fund development.

In the last five years, she’s authored over 300 articles for credit unions, digital banks, and financial professionals. Morgan is also the author of “77 Tips for Preventing Elder Financial Abuse,” a book focused on helping caregivers protect the elderly from financial scams.

In addition to her writing skills, she brings real-world financial acumen thanks to her previous experience managing rental properties as part of a \$34 million real estate portfolio.