How To Calculate Interest on a Loan
Written by
Karen Doyle
Edited by
Melanie Grafil
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When you borrow money, you’ll also pay interest on top of the amount you borrowed. Interest is the money the lender gets for loaning you the money.
Interest is expressed as a percentage of the loan amount. For example:
- 5% or 6% for a car loan
- 25% or more for a credit card balance
It may be charged monthly, annually or over the full term of the loan. Typically, the percentage is expressed annually. For instance, on a 5% loan, you’d pay 5% of the loan amount each year.
How To Calculate Interest on a Loan: Simple Interest Formula
To calculate the interest on a loan using the simple interest formula, use this equation:
Interest = Principal x Rate x Time
Where principal is the amount you borrowed, rate is the annual interest rate expressed as a decimal, and time is the loan term in years.
How Simple Interest Works: An Example
Suppose you take out a $5,000 loan at 6% interest for two years. To calculate the amount of interest you will pay, use the simple interest formula above.
Interest = $5,000 x 0.06 x 2
You would pay $600 in interest over the life of this loan.
How To Calculate Monthly Loan Interest
Since most loans require a monthly payment, it’s helpful to be able to determine the interest rate using months as well. To do so, just divide the annual interest rate by twelve and express the time in months instead of years.
The monthly formula becomes:
- Interest = (Principal x Rate/12) x Time in Months
- Interest = $5,000 x 0.005 x 24
The total amount of interest paid is still $600. This formula is useful if your loan term is not an even number of years, such as 30 months.
Types of Loan Interest Rates
Not all loan interest rates are created equal. Be sure you understand which type of interest your loan has, and what that means for your payment.
Fixed Interest Rate
A fixed interest rate stays the same for the life of your loan. You know when you take out the loan exactly how much interest you will pay in total over the life of the loan. A fixed interest rate loan is easiest to budget for, since the interest rate, and therefore your payment, won’t change.
Variable Interest Rate
A variable interest rate can go up or down, and the amount of your monthly payment will change accordingly. A variable interest rate loan is harder to budget for, since you don’t know how the rate will change in the future.
Credit cards often charge a variable interest rate, which may make your minimum monthly payment vary over time.
Simple vs. Compound Interest
Interest may be simple or compound. Simple interest is calculated on the original amount of the loan and then spread out over the term of the loan. Compound interest is calculated on the original loan amount, and on the interest that accrues over time.
If the interest on your loan compounds, you’ll pay more in interest than you would if your loan had simple interest.
Calculating Compound Interest
Here’s the calculation for compound interest on a loan.
A = P(1+r/n)^nt
The Formula for Compound Interest
- A = Amount you will pay in total, which is principal plus interest
- P = Principal
- r = Annual interest rate
- n = number of times interest is compounded each year — annual = 1, monthly = 12
- t = time or duration of the loan in years
Monthly Compounding: An Example
If interest is compounded monthly, the calculation is:
A = $5,000 (1+ 0.06/12)^ntA = $5,635.80
- Principal: $5,000
- Interest rate: 6%
- Compounding frequency: Monthly or 12 times a year
- Time: 1 year
How To Figure Out “How Much Interest Will I Pay?”
Interest is often represented as annual percentage rate (APR). If the term of your loan is more than one year, APR, while important, won’t tell you the whole story. Look at the total amount of interest you’ll pay over the life of the loan.
What Affects How Much Loan Interest You Pay?
When determining how much interest you will pay on a loan, you need to look at the three primary factors:
- Principal
- Term length
- Interest rate
Each of these factors will impact how much interest you will pay over the life of the loan.
Principal
Principal is the amount you borrow. So, the more you borrow, the more interest you will pay.
- A $5,000 loan at 6% simple interest for two years will cost you $600 in interest.
- A $10,000 loan at the same rate and term will cost you $1,200 in interest.
Term Length
The term length is another major factor in determining how much you will pay in interest over the life of the loan.
- If you take out a $5,000 loan at 6% simple interest for one year, you’ll pay $300 in interest.
- If you take the loan out for two years, you’ll pay $600 in interest.
Interest Rate
Likewise, a higher interest rate means you’ll pay more in interest.
- A two-year, $5,000 loan at 6% simple interest will cost you $600 in interest.
- That same loan at 8% interest will cost you $800 in interest.
If the interest on your loan is compound, there is another factor that can influence how much interest you will pay for your loan. That’s the frequency of compounding. A loan with interest compounded monthly will cost you more than one that compounds annually.
How Interest Works on Different Types of Loans
Interest may work a bit differently on different types of loans, or there may be additional costs or fees involved. The chart below offers a comparison, along with important things to know about interest, terms and fees.
| Loan Type | Interest Type | Available Terms | Other Costs |
|---|---|---|---|
| Personal loan | Usually fixed, may be simple or compound | Usually 2 to 10 years | May have an origination fee |
| Credit cards | Usually variable, compound | Revolving | May have an annual fee |
| Auto loan | Usually fixed, compound | Up to 7 years | May have dealer fees |
| Mortgage | Fixed or adjustable, compound | 15, 20 or 30 years | Application fee, closing fees |
4 Common Mistakes To Avoid When Calculating Loan Interest
Calculating loan interest can be tricky, and it’s easy to make a mistake. Here are some mistakes to avoid as you’re crunching the numbers:
- Forgetting to adjust for monthly compounding: Always convert the rate and time to monthly if you’re calculating monthly compounding interest.
- Mixing up simple and compound interest: This is a common error that can lead to miscalculations.
- Ignoring fees and extra charges: Don’t forget to add these to your principal when calculating interest.
- Trusting calculators and not double-checking: You can use many different online calculators, but just be sure to input the data correctly.
FAQs About Calculating Loan Interest
Here are some answers to frequently asked questions about how to calculate interest on a loan:- What's the formula to calculate loan interest?
- Calculate simple interest using the formula: Interest = Principal x Rate x Time
- For compound interest, use: A = P(1+r/n)^nt
- Where A is the total amount paid — principal and interest. P is the principal, r is the rate and n is the number of times interest is compounded and t is time.
- How do I calculate the interest rate if I know the payment amount?
- If you know the payment amount and the number of payments, you can calculate the total amount that will be paid on the loan — principal and interest. You can then plug those numbers into the interest formula above to determine the interest rate.
- Is there a difference between APR and interest rate?
- Yes. The APR includes fees and other costs that may be added to the loan. If the APR is higher than the interest rate, you know you are paying fees on top of interest for your loan.
- What are some tips to reduce the amount of interest you'll pay?
- The factors that go into determining the amount of interest you pay are the principal, the interest rate, the length or term of the loan, and compounding. Adjusting any of these will change how much interest you pay. If you borrow less money — principal, you'll pay less interest. If you find a lower interest rate, you'll pay less total interest on your loan. If you pay off the loan in less time — length, you'll pay less interest. And if you find a simple interest loan, or one that compounds less frequently, the total amount of interest you pay will go down.
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- Office of Financial Readiness "Understanding Interest and How To Calculate It"
- Bureau of the Fiscal Service "Simple Daily Interest"
- Investor.gov "Compound Interest Calculator"
- Consumer Financial Protection Bureau (CFPB). "How does paying down a mortgage work?"
- U.S. Department of Education "FAQs - Interest and Fees"
- FDIC "Chapter 5: Compound Interest"
- Ent Credit Union. "How to Calculate Compound Interest."
- CFPB. 2024. "What is the difference between a loan interest rate and the APR?"
