How loan payments are calculated
Nearly all personal, auto and student loans are amortized: you pay a fixed amount each month, and each payment is split between interest on the remaining balance and repayment of the balance itself. Early payments are interest-heavy; late payments are mostly principal. The fixed payment comes from the standard amortization formula:
PMT = P · i / (1 − (1+i)−n)
where P is the amount borrowed, i the monthly rate and n the number of payments.
A worked example
Borrow $20,000 at 8.5% for 5 years and the payment is about $410 a month. Sixty payments of $410 add up to roughly $24,600 — so the loan costs about $4,600 in interest, or 23% of what you borrowed. Stretch the same loan to 7 years and the payment falls to about $317, but total interest climbs past $6,600. Longer terms buy breathing room at a real price.
Reading the trade-offs
- Term is the biggest lever on total cost. Shorter terms mean higher payments but dramatically less interest.
- Rate shopping pays. On a $20,000/5-year loan, each percentage point of rate is roughly $550 of lifetime interest.
- Watch for fees. Origination fees effectively raise your rate. Compare loans by APR, which folds mandatory fees in, not the headline rate alone.