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Lenders charge interest in two main ways – simple or amortization schedule. The method of calculating total interest fees differs between the two accrual types. You can use a calculator, but understanding the mechanic will make you a knowledgeable borrower.
With amortization loans, some of the interest payments decrease over time, and the portions go towards your main balances increase. In a simple interest loan, the interest paid on each payment remains the same for the life of the loan.
How to calculate simple interests in a loan
Simple profits are most commonly used for short-term loans, such as payday loans, personal loans, and some car loans. It’s easiest to understand and calculate.
Monthly payments are revised, but the interest paid each month is based on your outstanding principal balance. If you pay off your loan early, you can save a significant amount of interest, assuming that your lender won’t charge you a prepaid penalty.
A simple formula for calculating interest
This equation can be used to calculate the total interest.
- Principal loan amount x interest rate x loan period = interest
For example, if you take a five-year loan for $20,000 and the interest rate on the loan is 5%, the simple interest formula would be $20,000 x .05 x 5 = $5,000.
Who will benefit from simple interests
Borrowers making on-time or early payments benefit from simple interest. Interest is calculated based solely on loan principals, so borrowers can save more on these loans than those with compound interest.
Types of loans that use simple interests
Simple profits are less common, but this interest can be encountered in short-term loans, such as payday loans and car title loans.
Those with student loans can also pay simple interest. For example, all federal student loans charge simple interest.
How to calculate loan amortization
Many lenders charge interest based on their amortization schedule. This includes mortgages, personal loans, etc. Automatic loan. Monthly payments for these loans are fixed. The loan is paid over time in equal installments. However, the way lenders charge interest changes over time.
The main difference between a loan amortization and a simple interest loan is that the initial payment on a loan amortization is generally high interest. This means that a small portion of your monthly payments are headed to the principal.
As time passes, the table changes as you approach the loan payoff date. Towards the end of the loan, the lender will apply most of your monthly payments to your principal balance, less to your interest costs.
Formula for calculating amortization interest
Here’s how to calculate interest on an amortization loan:
- Divide the interest rate by the number of payments made for that year. If you have a 6% interest rate and make a monthly payment, you will split 12 pieces of 0.06 and get 0.005.
- Multiply that number by the remaining loan balance and find out how much you will pay for the month. If you have a loan balance of $5,000, the first month will be $25.
- Reduce that interest from your fixed monthly payments and see how much principal will pay in the first month. If your lender tells you that your fixed monthly payment is $430.33, you will pay $405.33 for the principal in the first month. That amount will be deducted from the outstanding balance.
The next month, repeat the process with the new remaining loan balance, and continue on every subsequent month. To earn total interest, add all your interest together.
This is a one-year personal loan amortization schedule of $5,000 at an interest rate of 12.26%, the average personal loan interest rate for May 2025.
| Payment date | payment | Main | interest | Total Interest | balance |
|---|---|---|---|---|---|
| June 2025 | $444.85 | $393.77 | $51.08 | $51.08 | $4,606.23 |
| July 2025 | $444.85 | $397.79 | $47.06 | $98.14 | $4,208.44 |
| August 2025 | $444.85 | $401.86 | $43.00 | $141.14 | $3,806.58 |
| September 2025 | $444.85 | $405.96 | $38.89 | $180.03 | $3,400.62 |
| October 2025 | $444.85 | $410.11 | $34.74 | $214.77 | $2,990.51 |
| November 2025 | $444.85 | $414.30 | $30.55 | $245.33 | $2,576.21 |
| December 2025 | $444.85 | $418.53 | $26.32 | $271.65 | $2,157.68 |
| January 2026 | $444.85 | $422.81 | $22.04 | $293.69 | $1,734.87 |
| February 2026 | $444.85 | $427.13 | $17.72 | $311.42 | $1,307.74 |
| March 2026 | $444.85 | $431.49 | $13.36 | $324.78 | $876.25 |
| April 2026 | $444.85 | $435.90 | $8.95 | $333.73 | $440.35 |
| May 2026 | $444.85 | $440.35 | $4.50 | $338.23 | $0.00 |
Those who benefit from amortized profits
Lenders benefit from amortization profits. These loans tend to have longer terms, so the total interest paid will be higher. And as your interest payments are on the forefront, if you pay off your loan early, you save less.
Types of loans that use amortized interest
Many types of installment loans use amortization interest, such as car loans, mortgages, and debt consolidation loans. You may also encounter amortized interest on your home equity loan.
Factors that may affect how much you pay
Several factors can affect how much you pay for funding. Some important variables include:
- Loan amount. The more money you borrow, the more interest you will pay. This is because interest is usually calculated as a percentage of the loan balance.
- interest rate. Your interest rate is the biggest factor in your loan cost. Even a 1-2% difference can add several hundred dollars over the lifespan of the loan. Always buy the best personal loan fees before applying.
- Credit score. Lenders use their credit score to assess risk. Higher scores unlock lower interest rates, but reducing your score can significantly increase your borrowing costs.
- Loan period. A shortened terms usually means higher monthly payments, but lower total interest paid. Longer terms will increase your repayments and often allow you to pay more interest overall.
- Repayment frequency. Paying more frequently, such as every other week rather than monthly, will help you reduce your principal faster and reduce your interest rate.
- Additional payments. Paying the minimum amount, especially early in the loan term, can reduce your principal and save interest money. Make sure the lender applies the additional amounts directly to the principal balance.
How to get the best loan interest
In several ways you may be able to increase your chances of getting the most advantageous interest rate on a loan.
- Improve your credit score. The most competitive interest rates are generally available to people with good credits to good credits.
- Select a shorter repayment timeline. The highest interest rates always come with the shortest loan. If you can afford to pay, you will pay less interest over time.
- Reduce the debt-to-income ratio. Your debt income (DTI) ratio is the monthly liability you pay and is the percentage of your total monthly income. When qualifying for a competitive loan, it is almost as important as your credit score.
- Compare offers. Loans are not all sizes of products. Each lender has its own product. You can prequalify with at least three different lenders to get the best rates. By prequalifying, you can check the terms and interest rates available to a particular lender without damaging your credit.
Conclusion
Before you get a loan, it is important to calculate the amount you will pay interest to understand the true cost of borrowing. Ask the lender if interest is valued using a simple formula of interest or amortization schedule. Then run the numbers using the appropriate formula or online calculator.
Also, be aware of factors that affect the interest you pay. It may be worth reducing, shortening or shortening your repayment period to keep your hard-earned money in your pocket.
