Whether you're using a personal loan to consolidate debt or make a large purchase, it's important to know what you'll pay in interest and fees over time.
Borrowing costs vary depending on your credit score, financial profile, repayment term, and loan amount. But generally speaking, a higher credit score and a shorter repayment term lead to a lower APR.
We'll walk you through how to calculate monthly payments and total interest for each personal loan you're considering, and help you weigh your options.
How to calculate loan interest
Most lenders charge simple interest every month based on your remaining loan balance. Since your loan balance decreases every month you make payments, so too does the amount of interest you pay.
If you're wondering why your payments don't go down as well, it's because lenders apply a smoothing process to your loan payments so that they stay the same throughout the loan's term.
In other words, as the amount of interest you pay on the loan reduces, the amount of principal you pay increases. This is called amortization and is applied to a wide range of installment loans, including mortgages.
Calculating amortization is complex, so it's generally best to use a personal loan calculator to determine loan interest and payments. That said, you can try to ballpark it with the following formula.
Simple interest
You can use the following formula to approximate simple interest for a personal loan:
- Interest amount = loan amount x interest rate x loan term
Just make sure to convert the interest rate from a percentage to a decimal. For example, let's say you're borrowing $10,000 with a 10% interest rate and a three-year term.
- Total interest amount = $10,000 x 0.10 x 3 = $3,000
Since you repay a personal loan in fixed monthly installments, you would divide the loan amount plus interest ($13,000) by the number of months in the term (36) to approximate the monthly payment.
In this case, that comes to $361 per month. But because you're paying down the loan balance as you go, that payment is actually too high. The real payment is $323 per month.
The longer your loan's term, the more important it is to use a personal loan calculator to get an accurate payment.
Compound interest
While not common, some lenders may use compound interest, charging interest based on the loan amount plus any interest that's accrued. Many credit card companies use compound interest when calculating your monthly payment, which can make it costly to carry a balance.
What is APR?
Most lenders express your borrowing costs as an annual percentage rate (APR). APR accounts for the interest rate plus any upfront fees, like an origination fee.
The APR is expressed as a percentage rate that represents your annual cost to borrow money. APR is helpful when comparing personal loans with different rates and fees, or comparing personal loans to other types of loans that charge fees instead of interest.
You might think you can calculate your total borrowing costs for the year by multiplying your loan amount by your APR, but because most personal loans are amortized, it isn't that simple.
Learn More: APR vs. Interest Rate on a Personal Loan
What is amortization?
Loans with fixed payments are typically amortized, which means more of your payment will go toward interest at the beginning of the term than at the end. This is because more interest accrues in the initial months of repayment since interest is assessed on your outstanding balance.
The exact formula for amortization is complex, but here's a rough estimation of how it works:
- First, the lender divides your interest rate (expressed as a decimal) by the number of payments per year. For example, if your loan comes with a 12% interest rate, the lender would divide 0.12 by 12 to get 0.01.
- Next, the lender multiplies 0.01 by your remaining loan balance each month. If you took out a $10,000 loan, you'd pay $100 in interest the first month.
- The lender then subtracts your interest payment from your total monthly payment to get your principal payment for the month.
- The following month, the lender subtracts your prior month's principal payment from your outstanding balance.
- Your lender uses the result (your remaining balance) to calculate your interest payment for the second month. The process is repeated each month.
Your lender will use an amortization calculator or software to calculate your monthly payment and prepare the amortization schedule. Doing the math by hand would be tedious, so you can use a calculator when comparing your loan options.
Note that some lenders use daily simple interest. If that's the case for your lender, you can save money on interest by making your monthly payment early, since interest will have accrued over fewer days.
Personal loan rates by credit score
The best advertised personal loan rates are reserved for borrowers with excellent credit. You'll pay more to borrow if you have poor credit. Below are the average fixed interest rates borrowers prequalified for in July 2024 based on their credit score bracket.
While the table provides a rough idea of what to expect, prequalifying with a handful of lenders is the best way to get a more accurate rate estimate.
Personal loan calculator exercise
Let's say you have a 750 FICO credit score and you want to take out a $15,000 loan with a three-year term. Find your estimated rate in the chart above. Then, using a personal loan calculator, plug in the following information:
- Loan amount: $15,000
- Interest rate: 16.17%
- Loan term: 3 years
Check your results against ours:
- Monthly payment: $529
- Total interest: $4,030
Debt consolidation loan calculator
Debt consolidation is the process of paying off existing debts with a new loan in exchange for a single monthly payment and, ideally, a lower interest rate. Since personal loans often have lower rates than credit cards, they're commonly used to pay off credit card debt and secure a lower monthly payment.
Plus, personal loan rates are fixed, whereas credit card rates usually are not. And, personal loans charge simple interest as opposed to compound interest (or interest on unpaid interest).
Your savings will depend on the interest rate you're eligible for, which is based on factors like your credit score and income. Furthermore, if you choose a debt consolidation loan with a longer term, you may pay more interest in the long run, even if the loan reduces your monthly payment.
To ensure debt consolidation is worthwhile, enter a few details about your existing debt and your new loan offer in the calculator below. Check the results to see what your monthly payment and total interest savings could be.
Check Out: Pros and Cons of Debt Consolidation
Fees for personal loans
While some lenders (like LightStream) offer fee-free loans to borrowers, many lenders add loan fees. Some common examples include:
- Origination fee: Many lenders charge this one-time fee, especially if you have bad credit. The origination fee is accounted for in the APR and is typically deducted upfront from the loan funds.
- Documentation fee: Similarly, your lender may charge a documentation fee for handling the paperwork for your loan.
- Credit insurance/disability insurance: These optional coverages pay off a portion of your loan or a specific number of monthly payments should you become disabled, lose your job, or pass away.
- Late fee: If you miss a due date or don't pay in full, your lender may charge a late fee.
- Return fee: If you make a payment without sufficient funds or write a check that bounces, your lender may charge a return fee, a check-refund fee, or an insufficient funds fee.
Check Out: Best Personal Loans With No Origination Fee
How to compare personal loans
- Find lenders based on your eligibility: Narrow down your options based on the qualification requirements. For example, if you have poor credit, consider a bad-credit loan from a lender that consider low credit scores, allows cosigners, or uses other data to evaluate you. If you have excellent credit, choose lenders with low advertised rates and fees.
- Research lender reputation: Look at customer reviews on websites like Trustpilot and ConsumerAffairs. Run a Google search to see if there are any complaints or regulatory actions against the lender.
- Prequalify with your top choices: If the lender offers a rate estimate based on a soft credit pull, go through the prequalification process. Do this with a handful of lenders, so you can compare your options. You can compare top lenders all in one place with Credible.
- Compare APRs: Identify which lenders offer the lowest annual borrowing costs, with interest and upfront fees.
- Consider the term and monthly payment: You'll pay less interest with a shorter term, but you'll get lower monthly payments with a longer term. Decide which is more important for your financial goals.
- Evaluate the total borrowing cost: Compare the total cost of each loan offer, based on the APR and term. Use a personal loan calculator if you need to.
- Weigh the importance of other features: Consider whether you'd like any additional perks, like a mobile app, unemployment protection, financial resources, or discounts for automatic payments. This may help you decide between two similar loan offers.
Check Out: APR vs. Interest Rate on a Personal Loan
How to get a low-rate personal loan
- Compare loan offers based on the criteria outlined above.
- Consider discounts offered, like those for autopay, direct payment, or membership.
- Improve your credit by making on-time payments and paying off your existing debt before applying for a loan. You can also try a credit improvement tool like Experian Boost.
- If you have a friend or family member with good credit willing to take responsibility for the loan if you can't make payments, consider lenders that allow cosigned loans or joint applications.
- If you have an asset, such as a home or vehicle, you may qualify for lower rates with a secured loan. Just ensure you can afford repayment, since the lender can seize your asset if you don't pay.
Check Out: How To Get a Low-Interest Loan
FAQ
Can you pay off a personal loan early?
Virtually all personal loan lenders allow you to make extra payments or repay your loan at any time, which can save you money on interest.
Learn More: Can You Pay Off a Personal Loan Early?
Can you refinance a personal loan?
Yes. Many people refinance to get a better interest rate or a lower monthly payment on their outstanding personal loan. Your current lender - for example, Upgrade - may offer personal loan refinancing for eligible borrowers. Or, you may need to work with a new lender to get the funds to pay off your existing debt. Make sure to get a few rate estimates for comparison.
Check Out: How To Refinance a Personal Loan
How to get a better interest rate
If you're not happy with the loan offers you receive, you can always try applying with a cosigner or co-applicant, offering up collateral, or improving your credit before reapplying. You might also research other lenders and evaluate the criteria they use to determine rates for each borrower.
Related Articles:
- Best Personal Loan Interest Rates
- Best Low-Interest Personal Loans
- Personal Loans Guide
- How To Apply for a Personal Loan
- How Does Applying for a Loan Hurt Your Credit?
- How To Improve Your Personal Loan Application
- How Does a Personal Loan Affect Your Credit Score?
- How Long Does It Take To Get a Personal Loan?
- How Much of a Personal Loan Can I Borrow?
- What Can Be Used as Collateral for a Personal Loan?
