How to Calculate Loan Payments (Step by Step)

The loan payment formula

The monthly payment on a fixed-rate loan is M = P × [r(1+r)^n] / [(1+r)^n − 1], where P is the amount borrowed, r is the monthly interest rate (the annual rate divided by 12), and n is the number of monthly payments (years × 12).

The formula answers one question: what single payment amount, repeated n times, pays off both the principal and all the interest that accrues along the way, landing at exactly zero on the final payment?

A worked example

Say you borrow $25,000 at 6.5% for 5 years. The monthly rate is 0.065 / 12 = 0.005417, and n is 60 payments. Plugging in: M = 25,000 × [0.005417 × 1.005417^60] / [1.005417^60 − 1] = $489.15 per month.

Over 60 payments you'll hand over $29,349 in total — meaning the loan cost you $4,349 in interest on top of the $25,000 you borrowed. That interest figure is the number to watch when comparing loan offers.

Why early payments are mostly interest

Each month, interest is charged on the remaining balance. At the start the balance is highest, so more of your fixed payment goes to interest. On the $25,000 loan above, the first payment includes about $135 of interest; by the final year it's under $30.

This is why extra payments early in a loan are so powerful: every extra dollar goes straight to principal, permanently reducing the balance that all future interest is calculated on.

Three ways to pay less interest

First, shorten the term: moving from a 6-year to a 4-year car loan raises the monthly payment but can cut total interest by a third or more. Second, shop the rate — a single percentage point on a mortgage is tens of thousands of dollars over 30 years. Third, pay extra principal when you can, and confirm your lender applies it to principal rather than future payments.