How to calculate interest on a loan (minus the math)

When it’s time to evaluate your financial options, getting clarity about what you’re looking at is half the battle. Understanding how interest works is like unlocking a secret door that leads to well-informed decisions that you can feel good about.

If you're thinking, No thanks, I don't do math, here’s a spoiler. You don’t need to. We’ll break down the basics so that you can use online calculators and tools with confidence, knowing exactly what you’re looking at when the results appear on the screen. 

Best way to calculate interest on a loan

Don’t bother sharpening a pencil when you want to figure out how much interest you’ll pay on a loan. The easiest and quickest way to get that number is to use an online interest calculator. 

Lenders can charge interest on all kinds of loans, including personal loans, student loans, auto loans, mortgages and home equity loans. The rates might be different, but when it comes to how to calculate interest on a loan, the process is more or less the same. You'll just need to know three things:

• Loan term (the length of the repayment period)

• Loan amount (also called the principal)

• Interest rate

Using online loan calculators to get the details you want

Do an online search for the type of calculator you need. For example, if you want to figure out how much interest you'll pay on a personal loan, you might type “personal loan interest calculator” into a search engine. 

You could do the same thing with student loans, car loans or HELOCs/home equity loans. Once you find the calculator you need, you just plug in those three numbers mentioned earlier to get the results. 

For example, say you're considering a five-year, $20,000 debt consolidation loan with a 10% interest rate. Here's what you'd get, using a personal loan calculator:

• Monthly payment: $425

• Total interest paid: $5,496

In a couple of clicks, you could also discover that the same loan with a 3-year term would have a higher monthly payment ($645), but you'd slash more than $2,000 off the total interest that you pay. Playing around with the numbers this way can help you decide which loan is right for your situation.

Simple interest

One thing to know about loan interest is that there's more than one kind: compound interest and simple interest. When you're talking about how to calculate interest on a personal loan or home equity loan, you're usually talking about simple interest. 

Simple interest is based only on the amount you borrow, the interest rate and the length of time you owe the debt.

Compared to compound interest, simple interest usually means a lower cost of borrowing. Each month, your interest charges go down as you make payments and your balance goes down. As long as you've got a fixed interest rate, the amount of interest you pay won't go up.

Simple interest is better for you when you borrow.

Compound interest

Compound interest is interest that’s charged on both the principal and the interest that's accrued. Credit cards are a great example of compound interest at work. 

When you carry a balance, most credit card companies charge interest every day. Each day, your credit card issuer will add interest to your balance based on what you owed the previous day. In other words, you’ll pay interest tomorrow on the interest that they charge you today.

Compound interest doesn’t make a huge difference in the short term, but the additional cost adds up over time. Let’s say you owe $1,000 at 18% for one month. With a simple interest loan you’ll pay $15 in interest. With compound interest, you’ll pay $15.11. That might not seem like a lot. But when the amount of debt is higher, and the length of time is longer, the additional interest diverts your money away from debt payoff and into the creditor’s pocket.

Compound interest is better for you when you’re saving and investing. 

What is an amortization schedule and how do you use one?

An amortization schedule tells you the progress you’ll make against the debt with each payment. Understanding how it works can help you save on interest charges.

The bigger your balance is, the more interest you’re charged. As your balance goes down over time, so do your interest charges. That’s why at the beginning of a repayment period, a larger part of your payment goes to interest. If you want to reduce the total interest that you pay on a debt, a very effective strategy is to make extra payments that lower your balance early in the life of the loan. An amortization schedule shows how this works by listing every single payment you’ll make on the loan, and how each payment will be divided between interest and principal.

Here's what an amortization table would look like for the 5-year, $20,000 loan mentioned earlier (we’ll show the first two payments and the last two).

Early in the loan, when you still owe close to the full $20,000, more of your payment goes to interest charges. You pay a little less interest every month, until at the end of the loan, you’re only paying a few dollars in interest on the small balance that you still owe.

How to calculate variable vs. fixed interest

Interest rates can be fixed or variable. Here's what that means in a nutshell:

• Fixed rates don't change; they stay the same over the life of the loan.

• Variable rates can go up or down over time, and they are always tied to a market rate that your lender watches.

So, does any of that affect how you calculate interest?

Nope, the formula remains the same. The only thing that changes is the amount of interest you pay when your rate changes. Read the fine print on a loan or credit card agreement to find out what kind of rate you have. 

Having all of these details available on demand could make you feel more comfortable talking to lenders before you make a financial decision. When it comes to your money, technology could make it easier to understand your options and the potential results. 

What's next

• If you've got loans or credit card balances, pull out your latest statements to check the rate you're paying and how interest is calculated.

• Consider whether consolidating debts into a new loan might save you money if you could get a lower rate. 

• If you're shopping for a new loan, consider getting quotes so you can compare costs. Use an online loan calculator to do the math ( here’s one you could try), and only talk to lenders who can check your credit with a soft inquiry that won’t affect your credit standing.