How to Calculate a Monthly Loan Payment

The Formula Lenders Use

Every fixed-rate loan payment — whether for a car, personal loan, or student loan — is calculated using the same standard amortization formula:

Where:

• M = Monthly payment
• P = Principal (the amount borrowed)
• r = Monthly interest rate (annual rate ÷ 12)
• n = Total number of payments (years × 12)

A Worked Example

Suppose you borrow $20,000 at a 7% annual interest rate for 5 years. Here is how the calculation works:

1. Convert the annual rate to monthly: 7% ÷ 12 = 0.5833% per month, or 0.005833 as a decimal.
2. Calculate total payments: 5 years × 12 months = 60 payments.
3. Apply the formula: M = 20,000 × [0.005833 × (1.005833)^60] ÷ [(1.005833)^60 − 1] = $396.02 per month.
4. Total paid: $396.02 × 60 = $23,761.20
5. Total interest: $23,761.20 − $20,000 = $3,761.20

Why the Monthly Rate Matters

Lenders quote annual percentage rates (APR), but interest accrues monthly. Dividing the annual rate by 12 gives the monthly rate. This is why a 12% annual rate does not mean you pay exactly 12% of your balance per year — the monthly compounding means you pay slightly more than a simple 12% calculation would suggest.

For a $10,000 loan at 12% APR over 1 year: simple interest would give $1,200 in interest. The amortization formula gives $1,069.80 — less, because each payment reduces the principal, and subsequent interest is charged on a smaller balance.

How Amortization Works Over Time

With a fixed monthly payment, the split between interest and principal changes every month. Early in the loan, most of each payment goes toward interest. As the principal decreases, more of each payment goes toward the principal. This is called an amortization schedule.

For example, on a $20,000 loan at 7% for 5 years, the first payment of $396.02 breaks down as: $116.67 interest + $279.35 principal. By the final payment, the split is approximately $1.97 interest + $394.05 principal.

What Affects Your Monthly Payment

Three variables determine your payment:

• Loan amount: Borrowing more increases the payment proportionally.
• Interest rate: Even a 1% difference has a significant effect over long terms. On a $200,000 mortgage, the difference between 6% and 7% is approximately $130/month.
• Loan term: A longer term lowers the monthly payment but increases total interest paid. A 5-year loan at 7% costs significantly less total interest than a 7-year loan at the same rate, even though the monthly payment is higher.

What This Formula Does Not Include

The standard amortization formula calculates principal and interest only. Your actual loan payment may also include origination fees, prepayment penalties, or (for mortgages) property taxes and insurance escrow. Always review the full loan disclosure documents from your lender for the complete payment amount.