How loan payments are calculated
A loan is paid off using a process called amortization. Every periodic payment is split between interest (charged on the remaining balance) and principal (which reduces the balance). The payment amount itself is constant for a fixed-rate loan and can be derived directly from the loan amount, rate, and term.
M = P × r(1 + r)ⁿ / ((1 + r)ⁿ − 1)P is the original loan amount, r is the periodic interest rate (annual rate ÷ payments per year), and n is the total number of payments. For a monthly-pay loan, use r = APR/12 and n = years × 12.
Worked example
Borrow $25,000 at 9% APR for 5 years (60 monthly payments). Monthly rate is 0.09 / 12 = 0.0075.
M = 25000 × 0.0075 × (1.0075)⁶⁰ / ((1.0075)⁶⁰ − 1) ≈ $519.00Total paid over 60 months is roughly $31,140, so interest cost is $6,140. The first payment is about $188 interest and $331 principal; the final payment is almost entirely principal.
Common loan types compared
| Loan type | Typical APR | Typical term |
|---|---|---|
| Personal loan (unsecured) | 8–24% | 2–7 years |
| Auto loan (new car) | 5–9% | 3–7 years |
| Auto loan (used car) | 7–14% | 2–6 years |
| Student loan (federal, US) | 5–8% | 10–25 years |
| Home equity line (HELOC) | Prime + 1–3% | 10-year draw + 20-year payoff |
| Credit card (revolving) | 18–29% | Open-ended |
| Payday loan | 300–500%+ APR | 2–4 weeks |
The rate you actually qualify for depends heavily on credit score, debt-to-income ratio, and whether the loan is secured by collateral. A drop of 50–100 points in credit score can double the rate on the same loan.
How rate and term change the payment
- Higher APR raises the monthly payment more than proportionally. The same $25k loan at 14% APR over 5 years costs $581/month — $62 more per month, $3,720 more total.
- A longer term lowers the payment but raises total interest. Stretching the example to 7 years drops the monthly to $402 but raises total interest to $8,795.
- Extra principal payments shorten the loan dramatically. An extra $100/month on the example pays the loan off about 13 months early and saves $1,395.
Secured vs unsecured loans
Secured loans are backed by collateral the lender can seize on default (a car for an auto loan, a home for a mortgage). Because the lender's risk is lower, secured rates are typically several percentage points below unsecured rates. The downside is obvious: missing payments puts the asset at risk.
Unsecured loans — personal loans, most credit cards, student loans — rely only on the borrower's credit profile. They are faster to obtain and have no asset risk, but carry higher rates and stricter approval criteria.
Reading the fine print
- Origination fee: typically 1–8% of the loan, deducted before disbursement. Affects effective APR.
- Prepayment penalty: some loans charge a fee for paying off early. Common on mortgages and car loans in some jurisdictions; rare on US consumer loans.
- Variable vs fixed rate: a variable rate moves with an index like SOFR or prime. Cheaper today, riskier over time.
- Balloon payment: a loan with mostly low payments and one large final payment. Common in car leases and some commercial loans.