How to Calculate Loan Interest (With Examples)

TL;DR

• Loan interest is the cost of borrowing money, based on your interest rate and remaining balance.
• Most personal and mortgage loans use amortization, where interest decreases over time.
• You can estimate total interest using a formula or a loan calculator.

Key idea

Loan interest is the price you pay for borrowing money. It is calculated as a percentage of the remaining loan balance and is included in each monthly payment.

Most modern loans are amortized loans, which means:

• Your monthly payment stays the same.
• The portion that goes toward interest decreases over time.
• The portion that goes toward principal increases over time.

The total interest you pay depends mainly on:

• Loan amount
• Interest rate
• Loan term

Even small changes in the interest rate can significantly affect the total cost.

Simple interest vs amortized interest

There are two main ways interest is calculated.

Simple interest

Simple interest is calculated only on the original loan amount.

Formula:

Interest = Principal × Rate × Time

Example:

• Loan: $10,000
• Rate: 5%
• Time: 3 years

Interest:

$10,000 × 0.05 × 3 = $1,500

Total repayment:

$11,500

This method is less common for long-term consumer loans.

Amortized interest

Most loans use amortization.

Interest is calculated each month based on the remaining balance, not the original amount.

This means:

• Early payments include more interest.
• Later payments include more principal.

Step-by-step example

Suppose you borrow:

• $15,000
• Interest rate: 7%
• Term: 5 years

Monthly rate:

7% ÷ 12 = 0.583% = 0.00583

Total payments:

5 × 12 = 60

Monthly payment is approximately:

$297

Total paid:

$297 × 60 = $17,820

Total interest:

$17,820 − $15,000 = $2,820

Why loan term matters

Longer loan terms reduce monthly payments but increase total interest.

Example comparison:

Loan: $20,000 at 6%

5-year term:

• Payment: $387
• Total interest: $3,220

8-year term:

• Payment: $263
• Total interest: $5,248

Lower monthly payment, but much higher total cost.

Common mistakes

• Looking only at monthly payment
• Ignoring total interest paid
• Choosing the longest term automatically
• Underestimating the impact of interest rate changes
• Forgetting about additional loan fees

Practical tips

• Compare multiple loan scenarios before borrowing
• Focus on total loan cost, not just monthly payment
• Consider shorter terms if affordable
• Avoid borrowing more than necessary
• Use calculators to estimate real cost

FAQ

How do lenders calculate loan interest?

Most lenders use amortization, calculating interest monthly based on remaining balance.

Why is total interest so high?

Interest accumulates over time, especially with longer loan terms.

Can I reduce loan interest?

Yes. You can reduce interest by:

• Choosing shorter terms
• Making extra payments
• Getting a lower interest rate

Is interest calculated daily or monthly?

Most consumer loans calculate interest monthly, but exact methods vary.

Related calculator

Want to see exact payments and total interest?

Try the Loan Calculator to estimate your monthly payment and total loan cost.

Disclaimer

This guide is for educational purposes only. Actual loan terms, fees, and calculations may vary by lender. Always review your loan agreement and consult a qualified professional if needed.