When you take out a loan, you have to pay interest. Simply put, interest is the cost you pay for the privilege of borrowing money. As you repay a loan, your monthly payments will go toward the principal or the original amount you asked for and interest. So how do you calculate monthly interest on a loan? You could use a loan payment calculator or do the math on your own. Below, we’ll take a closer look at this very common question.
Why Monthly Interest Calculations Are Important
Chances are you have monthly bills, like your mortgage, car loan, utilities, and groceries. If you’d like to budget for your loan, it’s a good idea to find out how much you’ll pay in interest every month. By doing so, you can ensure you always have enough cash to make your monthly payments and reduce the risk of default.
Example of a Monthly Interest Rate Calculation
To calculate your monthly interest rate, divide the annual percentage rate (APR) by 12. This way, you’ll reflect the amount on the 12 months of the year. You’ll also need to convert this amount from a percentage to a decimal format.
Let’s say you have an APR of 10% and want to determine your monthly interest rate on a $4,000 loan. These steps will help you do so.
- Divide by 100 to convert the APR from a percent to a decimal: 10/100= 0.10
- Divide that number by 12 to get the monthly interest rate expressed as a decimal: 10/12=0.0083.
- Multiply that number by the total amount: 0083 x $4,000 = $33.20 per month
- Convert the monthly rate in decimal form to a percentage by multiplying by 100: 0083 x 100 = 0.83%
In this scenario, your monthly interest rate is 0.83%. If you don’t want to do the math yourself, you can also use a personal loan calculator to make things easier.
In addition to interest, many lenders charge a variety of fees, such as:
- Origination fees: A personal loan origination fee is the most common fee and will cover the cost of processing and underwriting your loan. Depending on the lender, you may pay anywhere from 1% to 10%.
- Application fees: Application fees are designed to pay for the cost of processing a loan application and vary by loan type, lender, and amount borrowed.
- Late payment fees: Late payment fees are charged by lenders as penalties for making payments past your due date. You might pay a flat fee or a percentage.
- Prepayment penalties: If you pay your loan off early, you may be on the hook for a prepayment penalty. This compensates the lender for the money they lost as a result of your early payoff.
In a perfect world, you would be able to take out a loan without paying interest and fees. Since this is not the case, it’s important to understand your monthly interest and fees before you sign on the dotted line of a loan agreement.