How to Calculate Loan Interest
Loan interest is where the "small print" lives — a rate that looks reasonable can cost thousands over a term. This guide explains the two kinds of interest, how monthly interest is charged, and how to compute the total.
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Simple vs Compound Interest
Simple interest is charged only on the original amount: $1,000 at 5% simple = $50 per year, forever. Compound interest charges on the unpaid balance including prior interest — which is how most loans (credit cards especially) actually work.
For most instalment loans the practical model is different again: each month, interest is charged on the current remaining balance at the monthly rate, and your payment covers that interest plus a principal reduction. This is amortization.
Monthly Interest on a Loan
A $10,000 personal loan at 9% APR: monthly rate = 0.09 ÷ 12 = 0.0075. First month's interest = 10,000 × 0.0075 = $75. If your payment is $250, the other $175 reduces the principal, and next month's interest is charged on $9,825 — slightly less.
Total Interest over the Term
The payment itself comes from the amortization formula. For the example above over 48 months, the payment is about $248.85, so total paid ≈ $11,945 and total interest ≈ $1,945 — nearly 20% on top of the amount borrowed.
Credit Card Interest Is Different
Credit cards compound daily at APR ÷ 365 on the carried balance, and the minimum payment barely covers the monthly interest. A $5,000 balance at 22% APR with a 2% minimum takes roughly 25 years to clear and costs about $9,000 in interest — the credit card interest calculator shows the exact timeline for your numbers.
Article FAQ
How is monthly loan interest calculated?
Multiply the balance by the annual rate divided by 12.
How much interest will I pay in total?
Multiply the monthly payment by the number of payments and subtract the principal.
Why do I pay less interest over time?
Because interest is charged on the shrinking balance — each month a little more of the fixed payment goes to principal.