Here’s How Personal Loan Lenders Calculate Your Monthly Payments

Loans can be a critical lifeline in times of unexpected crisis, or a tool making upward mobility possible — so long as lenders understand the costs.

“Personal loans can help you cover almost any purchase or consolidate higher-interest debt,” says Leslie Tayne, the founder and head attorney at Tayne Law Group, who specializes in consumer debt. Common uses include paying for home improvements, medical bills, or unexpected expenses.

“The borrower gets one lump sum and then pays it back through a series of fixed monthly payments for a fixed repayment period, making it easy to budget for and knowing exactly when the loan will be paid off,” explains Matt Lattman, vice president of personal loans at Discover Loans.

However, even if you get a fixed repayment period and amount, you might not know exactly how the lender calculates your monthly payment. And it matters: Understanding how to calculate loan payments gives you an insight into the total cost of the loan, plus how you could potentially save money.

Here’s what you need to know about loan payment calculation and how it can impact the amount you repay over time.

How personal loans work

Personal loans are usually unsecured, meaning you don’t need collateral to get them. You receive a lump sum from the lender, and the money can be used for a number of purposes.

Many personal loans have a fixed interest rate and accrue what’s known as simple interest, explains Tayne. “The interest you pay will be based on the principal only, compounding interest where unlike the interest accrues additional interest,” she says.

Because a personal loan usually has a fixed interest rate and payment and is fully amortizing — meaning it’ll be completely paid off at the end of the loan term — you’ll know the total number of loan payments from the start and can plan your budget accordingly.

amortizing loans

An amortizing loan is a type of loan structure that is designed to reduce what you owe over time. It ensures that your payment is first applied to the interest accrued during the payment period before it’s applied to the principal. Most personal loans, along with mortgages and car loans, are amortizing loans.

With amortizing personal loans, Lattman says, your monthly payment is divided between interest and principal. Interest is typically accrued daily over the life of the loan, and the daily interest charge will change as the principal balance is paid down, he explains. At the beginning of the loan, a higher percentage of your payment might go toward interest fees. By the end of the loan term, though, the bulk of your monthly payment goes toward reducing the principal.

“Amortization is really just a math problem to figure out the amount of principal you need to pay each month in order to keep your payment amount the same, and make sure that you’ve paid back in full at the end of your loan,” Lattman says.

Say you take out a $15,000 loan with a 6.99% APR for 72 months. Using the amortization schedule created with NextAdvisor’s loan calculator, you can see how much of your monthly payment goes toward interest, how much goes toward principal, and how those numbers change each month.

datesTotal amount paidTotal interest paidTotal principal paidbalance
January 11, 2022$255.66$86.39$169.27$14,831.72
February 11, 2022$255.66$85.41$170.25$14,662.45
March 11, 2022$255.66$84.42$171.24$14,492.20
April 11, 2022$255.66$83.42$172.24$14,320.96
May 11, 2022$255.66$82.42$173.24$14,148.72
June 11, 2022$255.66$81.41$174.25$13,975.47
July 11, 2022$255.66$80.39$175.27$13,801.22
August 11, 2022$255.66$79.37$176.29$13,625.95

You can get a feel for how this process starts for the first several months of payment. At the end of the amortization schedule, below, you can see how almost nothing is going toward interest, and the last payment is entirely principal.

datesTotal amount paidTotal interest paidTotal principal paidbalance
August 11, 2027$255.66$5.87$249.79$1,008.19
September 11, 2027$255.66$4.42$251.24$758.40
October 11, 2027$255.66$2.95$252.71$507.16
November 11, 2027$255.66$1.48$254.18$254.45
December 11, 2027$255.66$0.00$255.66$0.27

There is a small balance remaining at the end of this example, which can be easily paid off.

Interest Only Loans

In some cases, you might be able to get an interest only loan. When you get this type of loan, Tayne explains, you start out only making interest payments. While this can give you some nice breathing room at first, it’s easy to get behind when your normal payments hit down the road. And in some cases, you’ll be required to pay off the entire remaining balance in a lump sum, which can be difficult to do.

Interest-only loans aren’t very common with personal loans, according to Lattman, and are more likely to be encountered as a type of mortgage. An interest-only HELOC is another common type of interest-only loan.

Loan payment calculation

In theory, calculating your loan payment is simple. You take the total amount you borrowed (known as your principal), and divide it over the number of months over which you agreed to pay back the loan (known as the term).

However, it gets tricky when you factor in interest fees. Interest is expressed as an annual percentage rate, or APR, even though most people make payments on a monthly basis. If your interest rate is 6.99%, for instance, you can’t just add 6.99% to the principal every month. Instead, your monthly interest is a fraction (one-twelfth) of what you pay over the course of a year (6.99%) — in this case, 0.5825%.

Loans can be complicated enough without adding algebra to the mix. If you don’t want to write out the calculations yourself, you can use a loan payment cost calculator to easily figure out your monthly obligation, as well as see the total amount you’ll pay in interest. But if you’re curious about the detailed math, here’s the formula that lenders use to calculate your monthly payments for an amortizing personal loan:

A = P {[r(1+r)n ]/ [(1+r)n-1]}

A = the amount of your monthly payment (what you’re solving for)
P = the principal (what you borrowed)
r = your monthly interest rate (your annual interest rate divided by 12 months)
n = the loan term in months

Using the previous example of a $15,000 loan with a 6.99% APR for 72 months, here’s what you get when you plug in the numbers:

A= 15,000 [(0.005825 x 1.00582572) / (1.00582572 – 1)]

A = 15,000 (0.008849/0.519198)

A = $255.65

In the example above, your monthly payments would be about $256.

origination fees

To add another layer, some lenders will also charge fees on their loans. According to Tayne, lenders commonly charge what’s known as an origination fee, which is basically a one-time administrative fee charged at the time of accepting and receiving the loan.

Origination fees commonly range from 1% to 8% of your loan’s balance, says Tayne. Rather than being added to your loan balance, you can expect the fee to be deducted from the amount you receive.

“So, if you borrow $5,000, and your origination fee is 5%, then you’ll only receive $4,750 when the lender disburses the funds to you,” Tayne says. “You’ll still pay interest on the full $5,000, though.”

How to Pay Off Loans Faster

One way to reduce the total cost of your loan is to pay it down faster. When you make extra payments toward the principal, you can reduce what you pay overall and pay off the loan before the original term ends.

However, you’ll want to check the fine print before you sign for a loan. Some lenders charge prepayment penalties for paying off your loan before the end of your term. When searching for a lender, be sure to find one that doesn’t charge prepayment penalties. Getting out of debt faster is meant to save you money; you don’t want to end up paying extra instead.

In addition to paying extra toward your principal, Lattman and Tayne recommend the following tips for getting rid of your debt faster:

  • Avoid borrowing more than you need
  • Cut discretionary spending and put the savings toward reducing debt
  • Refinance to a shorter term or a lower interest rate
  • Look for ways to increase your income and put the extra money toward debt reduction
  • Use windfalls to make a lump sum payment against your principal

As you decide whether a personal loan is right for you, look beyond the APR and consider the impact on your budget.
“In addition to your APR, it’s critical to look at your monthly payment amount and the repayment term and see how those fit into your budget,” Lattman says. “Can you plan for, say, $250 a month for three years? If not, you might need to rethink.”