How loan payments are calculated

Most loans use equal monthly payments. Each payment covers the interest that built up during the month, and whatever is left reduces the amount you owe. Early payments are mostly interest; later ones are mostly principal.

This is called amortisation. It is why paying off a loan early saves much more interest than the same extra payment made near the end.

The monthly payment is P × r × (1 + r)^n ÷ ((1 + r)^n − 1), where P is the amount borrowed, r is the monthly interest rate (the annual rate divided by 12) and n is the number of monthly payments.

For a 10,000 loan at 5% a year over 5 years, r is 0.05 ÷ 12 and n is 60. The payment comes to about 188.71 a month, and the total paid is about 11,322.74, so the interest cost is roughly 1,322.74.

Three levers matter: the amount, the rate and the term. A longer term lowers the monthly payment but raises the total interest. A lower rate reduces both.

Fees, insurance and the way a lender counts days can all move the real figure. Use a calculator for an estimate and the lender's loan estimate for the final numbers.

A mortgage uses the same formula, applied to the home price minus your down payment. The result covers principal and interest only.

Property tax, home insurance, mortgage insurance and association fees are usually added to the monthly bill, so budget for more than the calculator shows.