How to Calculate Interest Rate on a Personal Loan

When you take a personal loan, it is crucial to familiarize yourself with the formula for calculating the personal loan interest rate. This helps to determine how much from your fixed monthly repayment goes into the principal sum and how much goes for interest. There are two types of interest rate: 

• The simple interest rate
• The amortizing interest rate

With simple interest, your monthly repayment amount remains fixed, but the interest you’ll pay each month varies, based on the amount of the unpaid principal sum. 

Amortizing interest means that a lump sum of your fixed monthly payment is diverted towards paying interest rather than the principal loan. But as you keep paying, a larger percentage of your fixed monthly payment begins to settle your principal sum, because you are clearing up the interest faster.

The monthly payment remains fixed; what changes is the allocation of the money. The amortizing interest differs from simple interest in that it is interest-heavy in the first phase of the repayment plan, whereas the simple interest rate is determined by what is due on the principal sum. So it may or may not be interest-heavy, depending on the principal sum and the term of the repayment. 

Today, we shall consider how to manually calculate both simple interest and amortizing interest. We shall also consider how to automatically determine your interest; whether simple or amortizing; using a personal loan interest rate calculator. 

Also read: Update on NIRSAL Loan: Application Procedure, Requirements and How to Check with BVN

How to Calculate Simple Interest on a Personal Loan

Creditors widely use simple interest. The formula for calculating simple interest on your personal loan is quite easy. You just need to know the total amount of your principal loan, your annual personal loan interest rate, and your loan term.

The Formula:

Principal loan amount x annual interest rate x loan term = interest. 

In other terms, Interest = P×R×L

For example, if you take out a one-year loan for ₦200,000 with a 15% interest rate, the simple interest will be calculated as follows: ₦200,000 x 0.15 x 1 = ₦30,000

To get your monthly interest amount, divide ₦30,000 by the monthly payments you would make. Let’s say you’re making 12 monthly payments. For instance, ₦30,000 ÷ 12 = ₦2,500, which is the additional amount you will pay as interest on the principal sum.

How to Calculate Amortizing Interest on a Personal Loan

Creditors usually use amortizing interest rates for longer-term loans. Though a bit more complex to calculate, amortizing interest is also a profitable way of accruing interest. It largely favours the lender, as it is interest-heavy from the onset. Below is a step-by-step guide on how you can calculate your amortizing personal loan interest rate: 

Step #1: Divide your monthly personal loan interest rate by 12 (for the 12 months in a year). But if your repayment plan is structured differently, for instance, if you pay only 7 times a year, divide the personal loan interest rate by 7. E.g.: A 6% personal loan interest rate will be calculated as 0.06 ÷ 12 = 0.005.

Step #2: Multiply 0.005 by your loan balance. This will give you the amount to be paid on interest for that month. E.g: A ₦100,000 loan balance will be calculated as ₦100,000 × 0.005 = ₦500 

Step #3: Subtract your interest for that month, i.e. ₦500 as calculated above, from your fixed monthly payment to deduce how much of the total payment for that month will go toward your principal balance. E.g., a fixed monthly payment of ₦20,000 will be calculated as ₦20,000 – ₦500 = ₦19,500.

Also read: Best Loan Apps with Low Interest Rate in Nigeria

Personal Loan Interest Rate Calculator: How it Works

Several loan facilities now provide a personal interest rate loan calculator on their websites. This is useful for customers who would like to estimate how much interest they might be paying on a loan before they begin their application. 

Based on the information you feed it—your loan amount, term of years of repayment and interest rate—the personal loan interest rate calculator will estimate the sum of interest that will accrue on your loan. However, this sum may increase or decrease, as the loan provider may consider other factors before finalising the interest rate to fix on your personal loan.

Thus, while a personal loan interest rate calculator is fast, easy and reduces errors, customers should note that it is not the final determinant of your Annual Percentage Rate (APR). Banks usually put this caveat on the personal loan interest rate calculator. 

Frequently Asked Questions 

What Are the Factors that Determine Personal Loan Interest Rate?  

The major factors that determine personal loan interest rate are the borrower’s creditworthiness, employment status and income, term of years for repayment, loan sum, and the cost of borrowing.

Also read: Does AI Help or Hurt the Tech Sector

Who Benefits from a Simple Interest? 

Borrowers are more likely to benefit from a simple interest, especially if you make early payments. This is because interest is calculated based only on the sum left on your principal loan. So, if you pay the loan early, you could save interest from accruing, unless your creditor charges a penalty for early repayment.

Do Short-term Loans Use Simple Interest? 

Yes. Lenders who provide payday loans, instant loans, car loans, student loans, etc. frequently use simple interest.

Know Your Finances 

Financial intelligence may be hard to acquire, but you can never go wrong with it. Having a sound knowledge of how your finances work will keep you organized and help you make informed decisions. 

So aside from knowing your personal loan interest rate and how to calculate your total interest, it is paramount to fill your mind with other financial insights. You may be wondering where you can get such insights. That’s why we’re here for you. Stay on our blog and you’ll be amazed at your financial growth in just a few months. 

Follow us for more on X or Twitter, @SiliconAfriTech.