People who take out a loan usually understand that they pay both principal and interest. What they may not fully understand is how much of their weekly, biweekly, or monthly loan payments are interest.
If you have a particularly simple loan, determining the interest you will have on it is quite simple. And if you have a calculator, everything is easy as you can be. But what if you are not sure of the formula and are you trying to calculate the interest on this loan? Not to mention the fact that, as the amount owed on a loan changes, it makes sense that the interest is. In addition, not all types of loans work in the same way.
Here's what you need to know to determine the interest on your loan.
Formula for calculating interest on a loan
Many types of loans, including student loans, mortgages, auto loans and business loans, are subject to a process called depreciation. Depreciation, in the context of loan repayment, is the fact that principal and interest are combined into a fixed amount to be paid at a constant rate (often monthly) for a specified period of time.
This means that when you make a loan payment, when you only look at the amount, you do not know what is the principal and what is the amount of the interest. But you can take it apart and understand it.
First of all, you will need several numbers before you can calculate the interest. Those are:
So suppose you have a commercial loan of $ 30,000 over 10 years with an interest rate of 6%. Depending on the provider of this loan, you will pay $ 333 per month for this loan. How much of this interest is?
Since the interest rate of this loan is 6% and you make monthly payments, use this formula to calculate the interest:
(Interest rate / 12) x loan amount = interest amount
We use 12 because we divide the annual rate by the number of times you make a payment during the year, which in this case is monthly. If you paid every week or every two weeks, it would be different.
So we divide first 6%, or 0.06, by 12, which is 0.005. 0.005 multiplied by $ 30,000 = 150.
$ 150 of this first installment of $ 333 is interest, which means you paid $ 183 of principal.
How to calculate interest with a depreciation table
You may have noticed that all this consisted of only calculating the interest on the initial payment. Now that you have paid $ 183 of the loan amount, the new amount you have left is $ 29,817. That means we now have to redo the full calculation to see how much interest is paid in the second installment. And the third installment, and the fourth and so on until the loan repayment.
To find out how much the amount of a loan is paid in interest and principal, and how much is left over, there may be some who are inclined to use a depreciation schedule. Also known as a depreciation schedule, this chart breaks down the specific elements of your loan so that you can see the details of what you are paying, where it is going and how much you have left.
If we continue with this business loan example, with the help of a depreciation schedule, the breakdown would begin approximately as follows:
Month Balance Starting Payment Interest Paid Balance Paid Remaining Principal 1 $ 30,000 $ 333 $ 150 $ 183 $ 29,817 2 $ 29,817 $ 333 $ 149.09 $ 183.91 $ 29,633.09 3 $ 29,633.09 $ 333 $ 148.17 $ 184.83 $ 29,448.26 $ 4 $ 29,448.26 $ 333 $ 147.24 $ 185.76 $ 29,262.50 5 $ 29,262.50 $ 333 $ 146.31 $ 186.69 $ 29,075.81 $ 6 29,075.81 $ 333 $ 145.38 $ 187.62 $ 28,888.19 7 28,888.19 $ 333 $ 144.44 $ 188.56 $ 28,699.63
And so on and throughout the 10 years. At the end of these 120 payments, you will have paid approximately $ 9,967 in interest on this $ 30,000 loan.
How to calculate the simple interest on a loan
All this can be a little complicated and difficult to handle. If you have a simple interest loan, thankfully everything is much easier to manage.
Simple interests are best used with short-term loans. Calculating the aforementioned 10-year commercial loan or even an even longer loan with a simple interest will not give you an accurate result. With a bank loan of a duration of one year, a simple calculation of interest may be preferable.
The formula for finding a simple interest on a loan is:
Principal x Interest Rate x Duration = Simple Interest
So, if we take the example of a bank loan for one year, let 's add it. Suppose this loan is worth $ 150 with a 5% interest. Connect everything: 150 x 0.05 x 1. The answer is that you will pay $ 7.50 in interest on this loan.
The simple interest calculation can be limited in the loans for which they work, but in a case like this, this is very useful and allows you to avoid ongoing calculations over time.
How to calculate interest on credit cards
Calculating the interest on your credit card can be a bit more complicated. You do not have a fixed and unchanging credit card balance because you can add money to it and you need to know how much interest is added each day of the year.
One important thing to know is that most credit cards do not charge monthly interest, but daily. It is not enough to know your annual percentage rate (APR); you will also need to know the daily percentage rate. Say you have a balance of $ 700 on your credit card with a 14% APR. If you do not add anything to the balance or pay anything until the end of the month, you will earn an average of $ 700 over 30 days.
We will have to calculate the daily percentage by dividing 14%, or 0.14, by 365. This gives us 0.00038356, or 0.038356%. If we multiply $ 700 by the daily rate, we get 0.268. Multiply that by 30 and you can estimate that you should pay about $ 8.04 in interest this month.
If you never add to this balance, it will remain on average the same amount. But what happens if the balance changes? Let's say that 20 days after the beginning of the month, you charge $ 200 more on the card, which brings you up to $ 900. You must now calculate the average daily balance for that month.
It was $ 700 for 20 days and $ 900 for the last 10 days of the month. ($ 700 x 20) + ($ 900 x 10) = $ 23,000. $ 23,000 / 30 = $ 766.67 from your average daily balance for that month. In this case, you multiply $ 766.67 by 0.038356% and get 0.294, and if you multiply by 30, you end up with an estimated interest of $ 8.82 a month.
These are estimates, but if your interest is compounded, you risk paying more interest than the APR.