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How to calculate capital and interest

Umito November 4, 2024

The loan amount you borrow is called the principal, and the interest is the cost of borrowing charged by the lender. To calculate principal and interest, multiply the principal amount by the interest rate and multiply the result by the number of years of the loan. Calculating principal and interest tells you how much simple interest loan will cost you.

However, the calculation of capital and interest becomes more complex if the loan uses another interest calculation, such as a amortized loan (A mortgage) Or compound interest (A credit card). With simple interest, your interest payments remain fixed, while amortized loans charge you more interest earlier in the loan. Learn about the types of interest lenders can charge you and how to calculate the principal and interest on a loan using a sample mortgage.

Key takeaways

To calculate the principal and interest for a simple interest loan, multiply the principal by the interest rate and multiply the result by the term of the loan.
Divide the principal by the months of the loan term to get your monthly principal payment on a simple interest loan.
A loan calculator is useful when calculating amortized loans to determine amortized interest payments, which gradually decrease over the life of the loan.
With fixed rate loans, your monthly payment will be consistent for simple or amortized interest loans.

Capital and interest

When you make a loan repayment, part of it goes towards paying interest and another part goes towards repaying your main. Understand how banks and credit unions Calculating these elements can help you understand how you will repay your loan.

Main

The principal is the original loan amount, not including interest. For example, with a mortgage, let’s say you buy a $350,000 house and put down $50,000 in cash. This means you borrow $300,000 of capital from the mortgage lenderwhich you will have to repay over the life of the loan.

Interest

THE interest is the amount charged by the bank to lend you money. Generally, shorter-term fixed rate loans, like personal loans, use a simple interest calculation. Longer term loans like mortgages and some car loans are amortized.

Example of calculating mortgage interest

Let’s say the loan in the example above is a 30-year mortgage with an annual interest rate of 4% that is amortized. Because you make monthly payments, the 4% interest rate is divided by 12 and multiplied by the outstanding principal on your loan. In this example, your first monthly payment would include $1,000 in interest ($300,000 x 0.04 annual interest rate ÷ 12 months).

If you enter your purchase price, down payment, interest rate and loan term in the form Investopedia Mortgage Calculatoryou will see that your monthly payments to the lender would equal $1,432.25. As noted earlier, $1,000 of your first payment strictly covers interest charges, meaning the remaining $432.25 goes toward paying off your outstanding loan balance or principal.

The example above does not include other costs, such as mortgage insurance And property taxes detained in escrow.

How depreciation works

If you have a fixed rate loanyour monthly mortgage payment remains the same. In theory, the interest rate is multiplied by a decreasing principal balance. The reason the amount you pay doesn’t decrease is because lenders use depreciation when calculating your payment, which is a way to keep your monthly bill consistent.

Note

With amortization, your monthly payment is primarily interest in the early years, with a smaller portion of the payment going toward principal reduction.

Example of depreciation

Using our previous example and assuming you don’t refinance, your loan payment will be the same 15 years later. But your principal balance will be reduced. In 15 years, you would have a remaining balance of approximately $193,000 of your loan principal.

Multiplying $193,000 by the interest rate (0.04 ÷ 12 months), the interest portion of the payment is only $645.43. However, you’re paying down more of the principal, meaning $786.82 of the $1,432.25 monthly payment goes toward principal.

The table below shows the monthly payments at different points in the 30-year mortgage. You will notice that the interest portion of the monthly payment decreases while the principal portion increases over the life of the loan. You can use a depreciation calculator to help you determine yours interest and principal of the loan amounts.

Amortization of the mortgage loan with distribution of capital and interest
Year	Main	Interest	Monthly payment
First year	$432.25	$1,000	$1,432.25
15 years	$786.82	$645.43	$1,432.25
20 years	$960.70	$471.54	$1,432.25
30 years	$1,427.49	$4.76	$1,432.25

During the last year of your mortgage, you pay back mostly the principal and very little interest. By leveling your payments in this way, mortgage lenders make your payments more manageable. If you paid the same principal amount over the course of the loan, you would have to make much higher monthly payments immediately after taking out the loan, and those amounts would drop at the end of repayment.

If you’re wondering how much you’ll pay in principal versus interest over time, the Investopedia Mortgage Calculator also shows the distribution of your payments over the life of your loan.

Adjustable Rate Mortgages

If you take out a fixed rate mortgage and only pay the amount due, your total monthly payment will remain the same for the duration of your loan. The portion of your payment allocated to interest will gradually decrease as more of your payment is allocated to principal. But the total amount you owe won’t change.

However, it does not work that way for borrowers who take out a adjustable rate mortgage (ARM). They pay a set interest rate during the initial loan period. However, after a while, a year or five years, depending on the loan– the mortgage “resets” to a new interest rate. Often, the initial rate is set below the market rate at the time you borrow and increases after the reset.

Your monthly payment may change on an adjustable rate mortgage because your outstanding principal is multiplied by a different interest rate.

Interest rate versus APR

When you receive a loan offer, you may encounter a term called Annual Percentage Rate (APR). The APR and the real interest rate which the lender billing you are two separate things, so it’s important to understand the distinction.

Unlike the interest rate, the APR takes into account the total annual cost of underwriting the loan, including costs such as mortgage insurance, discount pointsready assembly costsand some closing costs. It averages the total cost of borrowing over the life of the loan.

It’s important to understand that your monthly payment is based on your interest rate, not the annual percentage rate. However, lenders are required by law to disclose the APR on the loan estimate they provide this to you after you submit an application, so you can get a clearer idea of how much you are actually paying to borrow this money.

Some lenders may charge you a lower interest rate but higher upfront fees, so including APR helps provide a more holistic comparison of different loan offers. Since the APR includes associated fees, it is higher than the actual interest rate.

The formula for calculating the principal and interest of a simple interest loan is SI = P * R * T where:

P = principal or amount borrowed

R = interest rate

T = duration or number of years of the loan

Frequently Asked Questions (FAQ)

How is my interest payment calculated?

Lenders Multiply your outstanding balance by your annual interest rate, but divide by 12 because you’re making monthly payments. So, if you owe $300,000 on your mortgage and your rate is 4%, you will initially owe $1,000 per month in interest ($300,000 x 0.04 ÷ 12). The remainder of your mortgage payment is applied to your principal.

What is depreciation?

Amortizing a mortgage allows borrowers to make fixed payments on their loan, even if their outstanding balance continues to decrease. At first, most of your monthly payment goes toward interest, with only a small percentage reducing the principal. Over time, it changes, so more of your monthly payment reduces your outstanding balance and a smaller percentage goes toward interest.

What is the difference between interest rate and APR?

The interest rate is the amount the lender actually charges you a percentage of your loan amount. In contrast, the annual percentage rate (APR) is a way of expressing the total cost of borrowing. Therefore, the APR includes expenses, such as loan origination fees and mortgage insurance. Some loans offer a relatively low interest rate but have a higher APR due to other fees.

The essentials

You probably know your monthly payment mortgage, car loanOr personal loan. However, calculating the breakdown of that money between principal and interest can help you understand how much your loan will cost you and how your loan will be repaid. You can perform these calculations yourself or turn to an online loan calculator.

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