How to Calculate Loan Interest and Pay Less Overall

On average, Americans carry $105,444 in debt, according to Experian.¹ That's a significant amount of money to owe, and interest charges can add thousands to your overall repayment cost.

How interest accrues on a loan depends on the loan type — simple, compound, or amortized. Learn how to calculate your interest costs and the key factors that affect how much you'll pay over the life of the loan.

How do I calculate interest on a loan?

There are three main methods lenders use to calculate interest:

• Simple interest
• Compound interest
• Amortized interest

Which method determines how much interest you pay and when.

Simple interest

Common uses: Short-term loans such as personal loans or auto loans

With a simple-interest loan, the lender only charges interest on the initial amount you borrowed (the principal). It doesn't add past interest charges onto the balance, so it's easier to calculate your interest charges.²

The formula for calculating interest on a simple-interest loan is A = P x R x T.

In this formula:

• A is the ending interest amount
• P is the principal
• R is the annual interest rate as a decimal
• T is the loan term in years

Say you take out a simple-interest loan for $1,000 at 5% interest over a five-year repayment term:

$1,000 (Principal) x 0.05 (Interest) x 5 (Years) = $250

Calculating simple interest, you'd pay $250 in interest — for an overall repayment cost of $1,250.

Compound interest

Common uses: Credit cards and unsubsidized student loans

A compound-interest loan calculates interest not only on what you originally borrow, but also on the interest accumulated from previous periods. With this structure, interest can cause your balance to grow quickly if you don't make regular payments.³

The formula for compound-interest loans is A = P(1+r/n)^nt.

In this formula:

• A is the ending amount
• P is the principal
• r is the annual rate as a decimal
• n is the number of times interest compounds per year
• t is the loan term

For example, $1,000 at 5% interest compounded monthly over five years would have an overall repayment cost of $1,283.36 — $283.36 in interest versus $250 on the simple-interest loan.

Run the numbers → See how your numbers add up with our compound interest calculator.

Amortized interest

Common uses: Mortgages, some auto loans, some student loans

Many loans use amortization — meaning a portion of each of your loan payments goes toward the principal and interest, but the amounts dedicated to each category changes over time. Early in your loan repayment, much of your payment goes toward the interest, but later payments put more toward the principal.

Most people use an amortization calculator rather than doing the math by hand, but the amortization formula is M = P × (r(1+r)ⁿ) / ((1+r)ⁿ − 1).

In this formula:

• M is your monthly payment
• P is the principal
• r is the interest rate per period (the annual rate divided by 12 for a monthly loan)
• n is the number of payments

Say you finance a $25,000 car at 6% interest over five years for a monthly payment of $483.32. Across all 60 payments, you'd pay $28,999.20 — about $4,000 in interest on top of the $25,000 you borrowed.

Run the numbers → Break down amortization with our mortgage calculator or auto loan calculator.

Compare: Simple vs. compound vs. amortized interest

What factors affect interest accruals?

The following factors can affect the interest rate and how much you’ll pay on a loan:

• Rate type — Loans can have fixed interest rates or variable interest rates. Fixed-rate loans have the same rate for the life of the loan, while variable-rate loans can fluctuate over time.
• APR — The APR is how much you pay in interest and fees over one year. Comparing APR rather than just looking at the interest rate can give you a more accurate picture of the cost of the loan.
• Loan term — Longer repayment terms can give you a more affordable monthly payment, but they usually have higher rates and you'll pay more in interest.

Tips for reducing interest

Regardless of how your loan is structured, you can save money on interest by following these tips:

1. Build credit before applying — Before taking out a loan, work on building your credit history. Paying down debt, keeping balances low, and making all of your payments on time can help you establish your credit.
2. Compare offers — Request quotes from several lenders and compare rates and terms.
3. Choose the shortest repayment term — Select the shortest loan term you can afford. Shorter terms tend to have lower rates, and you'll pay less in interest over time.
4. Make extra payments — If possible, pay more than the minimum required. Every extra dollar you put toward your debt can reduce how much interest builds.
5. Avoid late payments — Avoid missing a payment or paying late to avoid penalty rates.
6. Refinance if rates drop or credit improves — If your credit improves or rates drop, you may be able to refinance your loan and qualify for a lower rate.

Your credit history plays a big role in the interest rate you’re offered, and even a modest improvement can help you pay less over time. Kikoff’s Credit Account is a free tool that reports your on-time payments to the major credit bureaus, helping you to build the credit history lenders look for.