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How loan interest is calculated
Most loans use amortizing interest, which means your monthly payment stays the same but the split between principal and interest changes each month. Early payments go mostly to interest; later payments go mostly to principal.
Monthly payment formula:
M = P × [r(1+r)ⁿ] ÷ [(1+r)ⁿ − 1]
P = Principal loan amount
r = Monthly interest rate (annual rate ÷ 12)
n = Total number of payments (years × 12)
M = P × [r(1+r)ⁿ] ÷ [(1+r)ⁿ − 1]
P = Principal loan amount
r = Monthly interest rate (annual rate ÷ 12)
n = Total number of payments (years × 12)
This is why paying even a small amount extra each month significantly reduces your total interest — it reduces the principal faster, which reduces the interest calculated each subsequent month.
Frequently asked questions
What is a good interest rate for a personal loan?
As of 2025, average personal loan rates range from 11% to 21% depending on your credit score. Excellent credit (720+) can qualify for rates as low as 6–8%. Credit unions often offer lower rates than banks. Always compare at least 3 lenders before accepting an offer.
How can I lower my monthly payment?
Three ways: (1) Borrow less, (2) Get a lower interest rate by improving your credit score or shopping around, or (3) Extend your loan term. Note that extending the term lowers your monthly payment but significantly increases the total interest you pay.
Does paying extra reduce the loan term?
Yes — any extra payment goes directly to principal, which reduces future interest charges and shortens your loan term. Even $50 extra per month on a 30-year mortgage can save tens of thousands in interest. Always specify that extra payments go to principal, not future payments.
What is APR vs interest rate?
The interest rate is the base cost of borrowing. APR (Annual Percentage Rate) includes the interest rate plus any fees (origination fees, closing costs, etc.), giving you the true cost of the loan. Always compare loans using APR, not just the advertised interest rate.