How to calculate interest rate on a loan.
Have you been thinking of what a loan and interest is, and how to calculate the interest of a loan? Hence, this article is put down for you. It will clear your reasons of doubts to the above mentioned items of discussion and how money lenders like banks make money through lending money to the borrowers.
When a lender lends you money or a bank decides to give you a loan, as far as it’s for business objectives, you’re expected to refund the money with some interest for the risk of giving out the money. So, it’s believed that they will charge you for the money lent to you and for their services too. It means you won’t just refund the money lent to you, you have to pay back the lent money which is called a loan and still pay additional money for the services known as interest. In a nutshell, let’s take a look at what a loan and interest means.
What is a loan? A loan means borrowing a sum of money from a lender with some interest.
What is interest?
Interest is the agreed amount of money you refund or repay when you borrow money from someone. It’s measured by the volume of the loan. The percentage is always referred to as an “annual rate”, and it’s often computed for a shorter or longer duration that’s not more than a year.
Interest is one of the major means through which money lenders like banks, credit unions or credit card issuers gain a profit.
Now that you have understood what a loan and interest means, let’s proceed to another amazing topic which is loan interest and how to calculate a loan interest.
What is a loan interest?
Loan interest is the agreed payment you refund to a lender that loans you some money. Let’s say, you want to get a personal loan of $30,000 from Mr. P, and he agreed on lending you $30,000 with an extra charges of $5, making it sum up to $35,000 for a period of a year. That extra money of $5 Mr.P added up is referred to as loan interest.
We have two major parts of a loan:
- The principal: Is the amount of money you borrowed.
- The interest costs: Is the amount you’re charged for borrowing the money, that’s the extra money you will pay for the money borrowed. You will also sign an agreement called a promissory note before you will be given this money to avoid future issues.
As you go on to pay back the loan for a duration of time, an amount of each payment you made goes to the exact amount you borrowed, this is known as “principal” and then, the other portion of the money goes to interest costs.
The sum of loan interest a lender charges is often inferred by your income, the amount of loan, the terms of lending and the recent amount of debt you already have.
How to calculate loan interest
To calculate loan interest sometimes requires a good mathematician to do the work, due to the different methods some lenders use when it comes to interest charges.
There are two main ways loan interest can be calculated.
- The Simple interest method.
- An Amortizing interest method.
Simple interest loan method
The simple interest loan method doesn’t need much difficulty to be calculated when you have the right information at hand. If your lender uses this type of method, all you need to do is to get the amount of the principal loan, the total agreed time to pay the money back, it could be in months or years depending on the agreement, and then, the interest rate. With these, you can calculate the simple interest without much stress.
Calculate the total interest by applying this amazing simple formula; Principal amount of loan × time( the agreed number of months or years) × interest rate is equal to interest.
The simple interest loan often comes with a shorter term loans.
- Amortization interest method:
This is one of the complicated ways most lenders used to calculate their interest on loans like; mortgage loans, auto loans, and students loans. The lender charges the interest based on amortization schedule, that’s the payment of this kind of loan interest, either weekly, or monthly, is fixed. With this amortizing type of calculating loan interest, the first payment is normally in big interest, that means the smaller part of the money you’re tasked to pay each month will be used in paying the principal loan percentage. And as time goes on, you continue making payments to your payoff time, but the terms changes due to the lender used the bulk of your monthly payments to fixed the principal balance and then less for the interest rates.
Calculation of amortization interest
To calculate interest based on amortization loans is not that easy, you need to be a guru in math to be able to calculate it well. Here’s a step to step guides on how to calculate amortization interest.
- Division: divide the interest fee by a total number of months in a year, that’s If it’s 5% interest fee with a monthly payment, then you need to divide 0.05 by the number of months in a year which is 12 to arrive at 0.004.
- Multiplication: To know balance interest fee you’re to pay next month, multiply the number you got from your division with the remaining balance of your loan. For instance, you already have $10,000 loan balance rate, you first interest of that month should be $10,000 × 0.004 (number from division) = $40.
- Subtraction: To check the principal rate you should pay in first month, Subtract the remaining balance from the fixed monthly fees. It means, if a money lender lets you know that your fixed payment each month is $440.22, you need to pay $400.22 to cover your first month principal. See the subtraction here: $440.22(fixed payment) – $40( remaining balance) = $400.22(principal to pay in first month).
- To know the amount of interest to pay next month: Follow the same process next month with your current last loan balance fee. Keep on doing this for each following month till you finish your payment.
Here’s a fixed interest cost amortize table illustrating the $5,000 for 4 months loan with 6%.
|The Payment dates||Payments||Principal||Interest||The Total Interests.||The Remaining Balance|
To calculate an amortization interest method is often difficult unless you have an amortization calculator that helps you do the work well, just by entering the first amount, sum of months, and then interest rate, the amazing amortized calculator will detect your each month’s payment.
Factors that could affect the amount of your interest rates.
There are lots of factors that could possibly affect the amount of your interest to pay when you borrowed money. Here are the majority of the factors.
- Loan term: this is the minimum time the lender gives you to repay the borrowed money. It has a serious effect on the amount of interest you will need to pay because the exact time the loan term takes, determines how much to pay, that’s the longer the loan term rate will generate lower monthly pay rate, but if you delay the repay out deadline, your payment may increase over the agreed time frame. And the shorter loan term normally comes with greater monthly repayments, however it will make out smaller interest payments due to your minimized payments time. According to Michael Sullivan, a financial consultant from America, he says, “Long term loans are the enemy of building wealth”. Therefore, you need to find out a loan term that suits your budgets and the debt load involved before going to get a loan.
- The amount of loan: The size of the loan you get determines the size of your interest. A larger loan attracts a bigger interest. For a lender to risks his money, lending it out to you, this will give rise to a huge pay of interest, says Jeff Arevalo, a financial expert. So you should be able to borrow based on how much money you need at the moment.
- The Interest rate: the exact interest rate to pay is determined by the amount of money borrowed. Before you plan for a loan, understand whether it’s a fixed or variable interest rate. Hence, it will be of great advantage for you if you work on how to enhance your credit scores first before going for a loan, this will broaden your chances of getting a favorable interest rate and lower paying loan rates.
- Payment chart: how frequent payment you pay to a lender is a great factor to be discussed when you consider getting a loan. As a great number of loans need weekly, or monthly fees, mostly business loans. There’s a benefit when you bring in your payments more often monthly, chances are that you will likely save more money. So if you really want to lessen your interest rate, you should consider exceeding the number of payments often than expected.
- Repayment rate: Is the exact amount of money you’re expected to repay monthly for the money borrowed. If you’re planning of adding additional money to each month pay, ask your lender if the additional money will go to your principal. If yes, then this will be a good way to save money and decrease debt interest rates payment.
How to obtain a good loan interest rates.
You can enhance your possibility of getting a decent interest rates in these ways:
- By going for a shorter payment time.
- By increasing your credit scores: maintaining a higher credit scores will enable you to have a smooth access to the best option of getting a loan, due to you have proven to be a creditworthy.
- By lessening your debt-to-income rate: when you constantly pay your old debt, you could be permitted to get a smaller interest rate for your current debt.
When a lender loans money to you, it’s normal that you will mostly pay an amount of interest for the risk of borrowing you that money because one thing is to borrow money and another thing is to pay back. Hence, you need to understand the kind of interest to refund. Sometimes, it’s difficult to do the calculation, so you have to make it easier by getting an online financial calculator to help you out, and also, you should have in mind that paying your loan balance promptly could decrease your interest rates thereby helping you to save more money.
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