When you obtain a loan, your fixed monthly payments are determined by the interest rate, the principal balance, and how long the repayment period is. Using an amortization calculator, you can determine what your monthly loan payment will be, as well as produce your debt repayment schedule, which breaks each payment down into principal and interest.

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What determines your loan payments?

Simply put, your loan payments depend on three variables:

  • The loan amount (principal)
  • The interest rate
  • The length of the loan (term)

Based on these three variables, a mathematical formula is applied to generate a fixed monthly payment, a concept known as amortization. The formula is a bit complex, so here's the easy version:

The simple-English explanation of amortization is that each of your fixed payments contains the amount of interest you owe, based on the principal balance at that point in time. The result of this is that because you still owe a lot of money early in the loan's term, more of your payment consists of interest. On the other hand, toward the end of the term, when there is little principal balance remaining, your interest is relatively small and most of your payment is applied toward the principal.

An example

If that explanation confused you, don't worry. Loan amortization is best explained with an actual example, so let's take a look at one.

Let's say that you want to obtain a $200,000 mortgage loan with a term of 30 years, and your bank has preapproved you for an interest rate of 4.5%. This would result in 360 equal monthly payments of $1,013. However, to show the effects of amortization, first consider the loan's initial three payments.

Monthly Payment

Payment Amount

Interest

Principal

Loan Balance

1

$1,013

$750

$263

$199,737

2

$1,013

$749

$264

$199,472

3

$1,013

$748

$265

$199,207

Data source: Author's calculations. Numbers may not add perfectly due to rounding.

As you can see, nearly three-fourths of the money you pay initially will go toward interest. Even though you send the bank a $1,013 check the first month, your outstanding balance decreases by only $263.

On the other hand, take a look at the last three loan payments you'll make:

Monthly Payment

Payment Amount

Interest

Principal

Loan Balance

358

$1,013

$11

$1,002

$2,015

359

$1,013

$8

$1,005

$1,010

360

$1,013

$3

$1,010

$0

Data source: Author's calculations. Numbers may not add perfectly due to rounding.

Your last few payments consist almost entirely of principal. Nearly every dollar you're paying in the loan's 30th year helps to lower your balance.

Calculate your loan payments

As I mentioned earlier, the formula for loan amortization is mathematically complex and, frankly, beyond the scope of this article. Fortunately, we have a calculator that can help you determine your loan payments.

 

* Calculator is for estimation purposes only, and is not financial planning or advice. As with any tool, it is only as accurate as the assumptions it makes and the data it has, and should not be relied on as a substitute for a financial advisor or a tax professional.

A couple of notes to help you get the most accurate estimate, and to get the most out of the calculator:

First, be sure to use a realistic interest rate -- it's best to err on the side of caution. For example, if you're certain you'll qualify for an auto loan with an interest rate between 4% and 5%, use the higher end for your estimate. This way, if you're wrong, you'll end up paying less than expected.

Also, notice the amortization schedule under the monthly payment line in the calculator's results. To really see how amortization works, set the table display to "monthly" and you'll see the interest you'll pay with each individual payment. Notice how your earlier payments (especially with a mortgage) are mostly interest, while the later ones are mostly principal. Because of this, any additional payments you make early in the life of the loan can save you a lot of money in interest over the term of the loan.

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