How to calculate interest on a loan
See how monthly interest is calculated from the outstanding balance and how to estimate total interest over a loan’s term.
On many amortizing loans, interest is calculated from the outstanding balance rather than the original principal. This explains why interest is highest near the beginning and why extra principal payments can reduce total cost.
Monthly interest formula
monthly interest = outstanding balance x monthly rateFor a 24% nominal annual rate, the simple monthly conversion is 2%. On $50,000:
50000 x 0.02 = 1000The first month’s interest is $1,000.
How one payment is divided
With a fixed payment of approximately $2,643.55:
opening balance = 50000
interest = 50000 x 0.02 = 1000
principal = 2643.55 - 1000 = 1643.55
new balance = 50000 - 1643.55 = 48356.45The following month’s interest is calculated from $48,356.45, not $50,000:
48356.45 x 0.02 = 967.13| Month | Payment | Principal | Interest | Remaining balance |
|---|---|---|---|---|
| 1 | $2,643.55 | $1,643.55 | $1,000.00 | $48,356.45 |
| 2 | $2,643.55 | $1,676.43 | $967.13 | $46,680.02 |
| 3 | $2,643.55 | $1,709.95 | $933.60 | $44,970.06 |
This is not “interest charged in advance.” The interest portion is larger because the balance is larger.
Total interest
Add the interest from every period, or—when payments contain only principal and interest—subtract the original principal from total scheduled payments:
total interest = 63445.32 - 50000 = 13445.32Keep insurance and fees separate so they are not mislabeled as interest. The loan amortization schedule guide explains every column.
Reducing interest with extra payments
An extra payment saves interest when it is applied to principal. In this $50,000, 24%, 24-month example, an additional $1,000 per month could shorten the term to about 17 months and save approximately $4,407.89 in interest.
Confirm that the lender permits prepayment, that no penalty cancels the benefit and that the money is credited to principal. Model the change in the loan calculator.
Frequently asked questions
Is interest based on the original principal or outstanding balance?
Many amortizing loans use the outstanding balance, but the contract controls.
Why is more interest paid near the beginning?
Because the opening balance is highest. As principal falls, periodic interest generally falls too.
Does an extra payment always save interest?
It can when applied to principal, provided fees or penalties do not offset the saving.