Several factors influence the monthly payments you make on a loan. The amount you borrow plays a critical role in determining the size of your monthly payment. If you borrow $5,000, you’ll most likely have a lower payment than if you borrowed $10,000, assuming you borrow either amount for the same length of time.
That said, how long you must repay the loan also influences your monthly payments. For example, the payment on a $5,000 loan with a 30-month repayment term (and an interest rate of 5.50%) is $177.95. If you borrow $10,000 and take 75 months to repay it (with a 5.50% interest rate), your monthly payment will be $157.14.
Interest, or the cost of borrowing money, also affects the monthly payment. Calculating this is a bit more complicated than dividing the loan’s principal by the number of months you must repay it. For example, $5,000 divided by 30 is $166.66, not $177.95, but added interest will increase your payments.
A lender determines interest based on several factors, such as the length of the loan and your credit history. How much you borrow can also influence the interest rate, as do market conditions. Usually, the longer the term, the higher the interest rate. A lender takes on more risk when giving a borrower more time to repay. The more time you must repay, the more opportunities there are for you to default on it or stop making payments.
A loan payment calculator can do the math for you, but if you’d like to crunch the numbers yourself to see how much you’ll pay each month, here’s what to do:
· If your rate is 5.5%, divide 0.055 by 12 to calculate your monthly interest rate. Your monthly interest is 0.004, or .4%
· Calculate the repayment term in months. If you’re taking out a 10-year loan, the repayment term is 120 months (12*10).
· Calculate the interest over the life of the loan. Add 1 to the interest rate, then take that to the power of 120. Subtract 1 and multiply 1.004120 by 0.004. Divide this by 0.006, resulting in 95.31.
· Divide the loan amount by the interest over the life of the loan to calculate your monthly payment.
Several factors can change your monthly payment amount. If you prepay the loan, you’ll end up paying less interest over time and are likely to finish paying it off before the end of the term.
Understanding Loan Terminology
When borrowing money, it’s essential to understand the terms a lender will use so you have a clear idea of what you’re borrowing and what your repayment responsibilities are. Knowing common loan terminology also gives you a clear picture of how much a loan will cost you in the long run. Some terms to know include:
· Loan Amount: Also known as the loan principal, this is the amount you’re borrowing. Depending on the type of loan, it can be anywhere from a few hundred dollars to hundreds of thousands of dollars. Your income and employment status play a role in determining the size of the loan amount, as do factors such as the collateral and your credit history.
· Number of Months: The number of months refers to the loan term broken down by the total months you have to repay it. For example, you have 360 months to repay a 30-year mortgage and 60 months to repay a 5-year personal or auto loan.
· Annual Interest Rate: The annual interest rate is the amount a lender charges you for borrowing money. It’s a percentage of the total amount you’ve borrowed. Interest can be simple or compound. A simple interest rate is calculated based on the loan principal. A compound rate is based on the amount of the principal plus any interest that has accrued.
· Payment Method: The payment method refers to whether the lender uses the start of the period or the end of the period to determine when your loan is due. There’s usually a slight difference in how much you pay monthly based on the payment method.
· Monthly Payment: The monthly payment is how much you need to pay every month to remain on good terms with your lender and up to date on your loan. While some loans charge a prepayment penalty if you pay more than the amount due each month, many don't, meaning you are free to increase the monthly payment amount to pay the loan off sooner.
· Total Interest: The total interest is how much you'll pay over the loan term if you make the monthly payments as agreed. One way to look at the total interest is the total cost of borrowing money. You can make your loan cost less by paying more toward the principal each month, provided there isn't a prepayment penalty.
· Total Principal and Interest: When you borrow $10,000, you don't end up paying back only $10,000 if there's interest on the loan. The total principal and interest amount are what you borrowed plus the interest charged over the loan term. Keep in mind that total principal and interest might not cover all the costs of borrowing money. Some loans have other fees, such as loan origination fees, affecting the overall cost.