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Calculating Interest on a Loan

Calculating Interest on a Loan
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When looking into your loan options, one of the most important things for a lot of people is the interest rate. You don’t want to have to pay more than necessary! And for some loans, calculating the interest is easy – the lender will let you know the annual interest rate. But with short term loans, which are repaid for less than a year, it can get a little more complicated.

That’s why we’ve gone through the basics of calculating loan interest rates below! You can make sure that you get the cheapest loan every time.

How to Calculate Interest Rate on a Loan

The interest rate for loans will almost always be given as APR, which stands for Annual Percentage Rate. If this is a fixed rate, you can use it to calculate the interest, but a representative rate is generally the average rate given, or the best case scenario.

For long term loans, the APR is an incredibly helpful piece of information. Even a fraction of a percentage can make all the difference in how much interest you’ll pay back overall, as we’re talking about very high balances. But with short term loans, which are usually for smaller amounts and not paid back on an annual basis, the APR can confuse matters.

A lot of short term loans offer Representative APR rates of over 1,000%. This doesn’t mean you’ll be paying thousands of pounds back in interest, regardless of your loan amount. A £100 loan over 7 days would actually cost around £5 in interest, not £1,000! You should be able to find the fixed daily interest rate for a loan on the lender’s website, which you can use to calculate how much interest you’ll pay overall.

For example, if the fixed interest rate is 0.8% per day, the daily interest for a £100 loan would be £0.80 – over a week this would add up to £5.60.

How to Calculate Loan Repayment

When it comes to calculating the monthly repayments for a loan, the lender should let you know what these would be before you sign the agreement. But if you want to double check the interest figures, this may be simpler than you think.

Often a lender will tell you the Representative APR, as well as a fixed percentage. The fixed percentage is the one you can use to determine the interest rate. The basic calculation is:

(Percentage Rate ÷ Number of Repayments in a Year) x Loan Principal

You can find an example of this below:

  • You’re looking to take out a loan of £20,000 over a 5 year period, with an interest rate of 7.2% p.a., making monthly repayments
  • (0.072 ÷ 12) x 20,000 = 120
  • You’ve now started reducing the principal balance, so to work out the interest you’ll pay moving forward, it gets a little more complicated, as you’ll have to figure out the new balance: Principal – (Repayment – Interest) = New Balance
  • The best way to work out your ongoing interest payments is to create a table
Month Starting Balance Repayment Amount Interest Paid Principal Paid New Balance
1 £20,000.00 £420 £120 £300 £19,580.00
2 £19,580.00 £420 £117.48 £302.52 £19,277.48
3 £19,277.48 £420 £115.66 £304.34 £18,973.14

Of course, you have to allow for human error, as well as slight deviations when it comes to rounding up and down, when you make these calculations by hand. You may end up deciding to simply trust that the lender has calculated your interest properly, or just use an online loan calculator!

Key Points
  • The APR (Annual Percentage Rate) is a good figure for long term loans, but is not that helpful for short term loans of less than a year
  • The basic calculation for interest is (Percentage Rate ÷ Number of Repayments in a Year) x Loan Principal
  • Once you have worked out the first interest payment, you’ll need to work out the new balance, and then create an interest table. The calculation for the new balance is Principal – (Repayment – Interest) = New Balance
  • There are a number of helpful loan calculators you can find online, particularly for big loans like mortgages
  • A lot of short term lenders will have a loan calculator on their website, so you can see what your repayments would be before you apply

Best Loan Calculator

The best online loan calculator will depend on what type of loan you’re applying for. The longer the loan term, the more complicated the interest becomes, as we’ve seen above! So if you’re applying for a mortgage, you’ll want to use a specialist mortgage interest calculator, whereas you can probably work out the loan repayments for a short term loan yourself.

Most short term lenders have loan calculators on their homepage, so you can find out the repayment amounts before you even start applying.

My Financial Broker work with a large number of short term lenders, who will have slightly different interest rates. We’ll do our best to match you with the cheapest lender, who is the most likely to approve your loan. Our no obligation application form is short and simple, and as we work on a commission basis with our lenders, our services are free for customers!

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