How to Calculate Loan Costs
When you take out a loan, the lender offers a loan amount at a certain annual interest rate and requires a strict payment schedule. Monthly payments are calculated using the formula shown on the figure shown here; the payments always include both principal and interest components. Loan costs are originated from the interest and can be computed as loan costs = (monthly payment x number of months ) - principal.
In the steps below, we will consider an example in which you want to calculate the cost of a $15,000 loan over three years at an annual interest rate (AIR) of 6 percent.
Other People Are Reading
Instructions
-
-
1
Calculate the number of months (N) and monthly interest (I).
N = 12 x number of years
I = AIR / (12 x 100%)
In our example, this means:
N = 12 x 3 = 36
I = 6% / (12 x 100%) = 0.005 -
2
Calculate the value (1 + I)**N (see figure) first to simplify computing the loan monthly payment (M).
S = (1+I)**N
In our example, this would be:
S = (1+0.005)**36 = 1.06**36 = 1.1967 -
-
3
Calculate the monthly payment (M) using the computed value S (see Step 2).
M = Principal x (I x S) / (S -1)
In our example, this would be:
M = $15,000 x (0.005 x 1.1967) / (1.1967-1) = $15,000 x 0.03042=$456.33. -
4
Calculate the total amount (T) to amortize the loan.
Total Amount = Monthly payment x Number of months
In our example, this would be:
T = $456.33 x 36 = $16,427.88 -
5
Calculate loan costs (C):
Loan costs = Total amount - Principal
C = $16,427.88 - $15,000 = $1,427.88
-
1
References
Resources
- Photo Credit Personal Collection
