How is your personal loan
interest rate determined?
What is interest?
Firstly, let’s establish exactly what interest is. An interest rate is a fee that you are charged for borrowing money, expressed as a percentage of the total amount of your loan. Whether you have a home loan, car loan or a personal loan, you will likely pay an interest fee along with your repayments.
Factors that will determine how much interest you pay
There are several factors that will affect how much interest you pay on your loan. Understanding interest and how much you end up paying will be beneficial for you to ensure you are getting the best interest rate possible. It will also help you budget and figure out exactly how much you end up paying on your loan.
Your principal amount is essentially how much money you are borrowing. Unfortunately, taking out a loan is not as simple as borrowing as much money as you want, as you need to borrow within your means to ensure you can repay your loan.
How long is it going to take for you to repay your loan? Typically, shorter loan terms accompany higher repayments, but less interest over time. Longer terms function oppositely, with lower monthly repayments and more interest costs over the life of your loan.
Let’s illustrate this with an example. Let’s say that you have borrowed $10,000 with a 5.95% interest rate p.a.
- If you repay this interest over 2 years, each month you will pay $443 which will add up to $632 in interest, or;
- If you repay this over 4 years, you will pay $235 monthly which adds up to $1,280 in interest.
You will likely have the option to repay your loan either weekly, fortnightly or monthly. More repayments will equal less interest, because of the effects of compounding. However, repaying your loan weekly will only be beneficial if you can reasonably manage it with your budget.
When you make your loan repayments, the entire amount does not go towards paying off your loan. A certain portion will go towards paying your interest and the remainder is taken from your loan principal.
Your interest rate on your loan will impact how much interest you pay. There are two types of interest rates: variable interest rates or fixed interest rates. When calculating your interest rate, ensure you use the basic annual interest rate and not the comparison rate. This is because the comparison rate accounts for fees and charges as well as interest, so using this in your calculations will amount to a higher interest amount than you should get.
How to calculate interest on your personal loan
If you wish to manually calculate how much interest you will be paying on your personal loan, there is a simple formula that you can use:
(Interest rate / number of payments) x loan principal = interest
Let’s use this formula as an example. Let’s say that you have a personal loan of $20,000 over a period of 5 years at an interest rate of 6.29% p.a. with a monthly payments schedule.
(0.0629 / 60) x 20,000 = 20.96
This is the amount you will pay back in interest. Now that you will have paid back some of your principal, the interest you repay will change. To figure out how much interest you will pay in the following months, you need to calculate your new balance. You can use this formula:
Principal – (repayment – interest) = new balance
So, using the same example, the new balance after one month will be:
20,000 – (236 – 20.96) = 19,979.04
Using these formulas for a period of 6 months, this is how your interest paid will change:
|Month||Starting balance||Repayment||Interest paid||Principal paid||New balance|
**It is important to note that doing calculations yourself, using this formula, will incur slight discrepancies due to rounding and human error. However, this will give you a good idea as to how much you will be paying in interest each month.
Nifty Loans personal loans
If you have been searching for a personal loan, Nifty Loans offers affordable personal loans from $500 to $10,000 with flexible repayment terms. The amount of interest you pay will depend on a few factors, including how much you wish to borrow and your current financial situation. We are an online lender, meaning that we can be more lenient in our credit score requirements. We can offer bad credit personal loans to eligible applicants.