How to calculate interest on your loan

How to calculate interest on your loan

Understanding how to calculate interest on loans will help you identify the most suitable loan for you. It will let you learn how much your loan will actually cost you so that you can make an informed decision among all the offers available.

Why should I calculate interest on my loan?

The sheer number of variety of loan offers on the market today can be confusing and bewildering. Do you know how much exactly you will need to pay as interest on the loan - i.e. how much the loan will cost you in interest charges? How do you decide which loan best suits your needs and affordability?

Understanding how to calculate interest on loans will help you identify the most suitable loan for you. It will let you learn how much your loan will actually cost you so that you can make an informed decision among all the offers available.  

Tools available to calculate interest on the loan

There is a standard mathematical formula used to calculate your monthly EMI (Equated Monthly Instalment) or the amount you have to pay every month to repay your loan. Your EMI includes both the interest on the loan plus repayment of the principal amount. There are three ways in which you can find out what the interest on the loan will be

  • Online sites: There are many websites that will calculate your interest cost for you if you provide the following information: 1. the amount you want to borrow 2.the interest rate charged and 3.the loan period.
  • Bank websites: Many of the bank websites offer an EMI calculator which allows you to see what your monthly outflow on repaying the loan will be, including how much money you are paying each month towards interest costs and towards repaying the principal. 
  • On your own: If you have a calculator, you can apply the formula and arrive at the cost on your own.

In this formula, the Principal is the total amount borrowed from the lender (which does not include interest),   represents the interest rate and n represents the number of payments over the loan period.

When you opt for a loan with a long repayment period, the interest rate will be relatively higher. If you opt for a loan with a shorter tenure, then you will be paying a lower interest amount.

During the initial years of repayment, most of your EMI goes towards paying off the interest charges. In the later stages of your tenure, much of the interest is already paid and most of your EMI goes towards repaying the principal.  

What is a Loan Amortisation Schedule?

If you are taking a home or auto loan, it is very useful to know the timetable of your repayment and the break-up of your monthly payments. This is found in your Loan Amortisation Schedule. It is a simple and clear table that details your repayment obligations (interest + principal) over the entire period of your loan. It includes:

  • Your outstanding balance before payment of each EMI
  • Your total EMI payment every month broken up into
  • -Your monthly contribution towards principal repayment - Your monthly contribution towards interest payment
  • Your outstanding balance after payment of each EMI

Your Amortisation Schedule will give you an accurate view on what your interest cost will be over the entire tenure of your loan and your total monthly outflow will be towards repaying the loan. This will help immensely in planning your monthly budget.

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