How to Calculate Loan Interest
Published January 10, 2026 · 9 min read
Every loan payment covers two pieces: interest and principal. To budget accurately or compare offers, you need to know how lenders calculate interest—whether simple, compound, or fully amortized. This guide walks through the formulas, shows real examples, and explains how extra payments cut total interest.
Core Formulas You Need
Simple Interest (interest-only)
Interest = Principal × Rate × Time
Rate is annual in decimal form; Time is years. Common for short-term personal, auto, or seasonal business loans.
Compound Interest (no payments during period)
Future Value = Principal × (1 + r/n)n×t
r = annual rate, n = compounds per year, t = years. Subtract principal to get total interest.
Amortized Loan (fixed payment)
Payment = (r × L) / (1 - (1 + r)-n)
L = loan amount, r = monthly rate (annual ÷ 12), n = total payments. Interest each month = remaining balance × monthly rate.
Step-by-Step: Calculate Loan Interest
For Simple Interest Loans
- Convert annual rate to decimal (e.g., 8% → 0.08).
- Set time in years (months ÷ 12 for partial years).
- Multiply principal × rate × time to get total interest.
- Add principal to get total payoff if interest-only.
For Compound Growth (no payments)
- Pick compounding frequency (annual, monthly, daily).
- Compute Future Value = P × (1 + r/n)^(n×t).
- Subtract principal to find interest accrued.
For Amortized Loans (most personal/auto/mortgage)
- Convert APR to monthly rate: annual rate ÷ 12.
- Set total number of payments: term years × 12.
- Use the amortization formula to find the fixed payment.
- Interest in month 1 = balance × monthly rate.
- Principal in month 1 = payment - interest. Repeat for schedule.
Real-World Examples
Example 1: Simple Interest (Short-Term Loan)
Scenario:
$10,000 loan, 8% simple interest, 18 months
Calculation:
Time = 18 ÷ 12 = 1.5 years
Interest = 10,000 × 0.08 × 1.5 = $1,200
Total payoff = $11,200
Total interest: $1,200
Example 2: Amortized Loan (Auto)
Scenario:
$25,000 auto loan, 6.5% APR, 60 months
Step 1: Monthly rate & term
r = 0.065 ÷ 12 ≈ 0.005417
n = 60
Step 2: Payment
Payment ≈ (0.005417 × 25,000) ÷ (1 - (1 + 0.005417)^-60) ≈ $489
Step 3: First-month split
Interest = 25,000 × 0.005417 ≈ $135
Principal = $489 - $135 ≈ $354
Total interest over 60 months: ≈ $4,340
Example 3: Compound vs. Amortized (Comparison)
Scenario:
$5,000 balance for 2 years at 10% APR
If no payments (compound monthly):
Future Value ≈ 5,000 × (1 + 0.10/12)^(12×2) ≈ $6,104
Interest accrued ≈ $1,104
If amortized over 24 months:
Payment ≈ (0.10/12 × 5,000) ÷ (1 - (1 + 0.10/12)^-24) ≈ $231
Total interest paid ≈ $544
Paying as you go with amortization can cut interest roughly in half versus letting a balance compound without payments.
How Extra Payments Reduce Interest
- Extra principal lowers the balance, so the next month accrues less interest.
- Even one extra payment per year can shave months off the term.
- Check for prepayment penalties before paying ahead.
- Ask your lender to apply overpayments to principal (not future interest).
APR vs. Interest Rate
The note rate drives your payment calculation. APR includes certain finance charges (origination, some fees) and expresses them as a yearly rate for comparison. Use the note rate for payment math, APR to compare offers.
Common Interest Calculation Mistakes
- Using the annual rate directly in monthly calculations without dividing by 12.
- Ignoring fees and points when comparing loans (APR clarifies total cost).
- Assuming simple interest when the loan compounds or amortizes monthly.
- Forgetting compounding frequency in compound interest problems.
- Not checking for prepayment penalties before making extra payments.
- Comparing only payment amounts instead of total interest over the term.
Frequently Asked Questions
How do I find interest in a specific month?
For amortized loans, multiply the current balance by the monthly rate (annual ÷ 12). Subtract that from the fixed payment to find principal for that month.
Is APR the same as the interest rate?
No. APR includes certain fees; the note rate is used in the payment formula. Compare APRs across lenders but use the note rate for monthly payment math.
Does paying every two weeks reduce interest?
Biweekly payments create 26 half-payments (13 full payments) per year, which can cut interest and shorten the term if your lender applies them as received.
Can I avoid interest by paying early?
Paying before the due date reduces daily interest on some simple or daily-accrual loans. On standard monthly amortized loans, extra payments reduce future interest by lowering principal.
What is negative amortization?
It happens when payments are too small to cover interest, so unpaid interest is added to the balance. Avoid loans with potential negative amortization unless you fully understand the risks.
How do prepayment penalties work?
Some loans charge a fee if you pay off early. Check your note; if allowed, target small, regular principal prepayments to reduce interest while avoiding penalties.
Which calculator should I use?
Use the Loan Calculator for payment schedules and total interest, and the Interest Calculator to compare simple vs. compound growth or test different compounding periods.