Guide
How loan payments are actually calculated
Why your monthly payment is the number it is — and why paying a little extra early does so much.
A fixed-rate loan — a car loan, a mortgage, a personal loan — has one slightly magical property: you pay the exact same amount every month, and at the end the balance lands precisely on zero. That number isn't guessed; it comes from one formula. Understanding it tells you why loans cost what they do, and where you can actually save money.
The three inputs
- Principal (P) — the amount you borrow.
- Rate (r) — the monthly interest rate, i.e. the annual rate divided by 12.
- Term (n) — the total number of monthly payments (years × 12).
The formula
The fixed monthly payment M is:
It looks intimidating, but it's just balancing two forces: the loan grows by the interest rate each month, and your payment chips it back down. The formula finds the single payment size that reaches exactly zero after n months.
A worked example
Borrow $20,000 at 6% a year over 5 years. The monthly rate is 6% ÷ 12 = 0.5% (0.005), and the term is 5 × 12 = 60 payments. Plug those in and the payment comes to about $386.66 a month. Over 60 months you pay roughly $23,200 — so about $3,200 of interest on top of the $20,000 you borrowed. You can check any scenario instantly with the loan calculator.
Amortization: why early payments are mostly interest
Here's the part that surprises people. Even though your payment never changes, its split between interest and principal shifts every month. Interest is charged on the balance you still owe, and early on that balance is large — so most of the payment goes to interest, and only a little to principal.
| Payment | Goes to interest | Goes to principal |
|---|---|---|
| Month 1 | $100.00 | $286.66 |
| Month 30 | $59.62 | $327.04 |
| Month 60 (last) | $1.92 | $384.74 |
As the balance falls, the interest slice shrinks and the principal slice grows — the loan pays itself off faster and faster near the end. This front-loading of interest is called amortization, and it's why the first years of a mortgage barely dent the balance.
Where you can actually save
- Shorten the term. A shorter loan has a higher monthly payment but dramatically less total interest, because the balance is high for less time.
- Pay a little extra early. Any extra goes straight to principal, and because early principal avoids the most future interest, small early over-payments have an outsized effect.
- Chase the rate, not just the payment. Lenders love to lower your payment by stretching the term — which quietly increases total interest. Compare total cost, not monthly cost.
Try it yourself
Rather than doing the algebra, run the numbers: the loan calculator handles any principal, rate and term, the mortgage calculator adds taxes and insurance for home loans, and once you understand that interest compounds, the compound interest guide shows the same force working for you when you save.