How to Calculate a Loan Payment: The Formula Explained

Every loan — car, mortgage, personal — has a monthly payment determined by three things: the loan amount, the interest rate, and the loan term. Most people just accept whatever number the lender gives them. But understanding the math lets you compare loans, negotiate better terms, and save thousands.

The Loan Payment Formula

The standard formula for a fixed monthly payment is: M = P × [r(1+r)^n] / [(1+r)^n − 1]. Where M = monthly payment, P = principal (loan amount), r = monthly interest rate (annual rate ÷ 12), n = number of payments (years × 12).

Step-by-Step Example

Suppose you borrow $20,000 at 6% annual interest for 5 years. Monthly rate r = 0.06 ÷ 12 = 0.005. Number of payments n = 5 × 12 = 60. Plugging in: M = 20,000 × [0.005 × (1.005)^60] / [(1.005)^60 − 1] = $386.66/month.

How Each Factor Affects Your Payment

• Loan amount: Borrow $25,000 instead of $20,000 at the same rate/term → payment jumps to $483/month
• Interest rate: Same $20,000 at 9% instead of 6% → payment rises to $415/month
• Loan term: Extend from 5 to 7 years → payment drops to $295/month but you pay $900 more in total interest

Total Interest Paid

Multiply your monthly payment by the number of payments to get the total you'll repay. Then subtract the original loan. The difference is interest. On the $20,000 example: $386.66 × 60 = $23,200 total repaid. $23,200 − $20,000 = $3,200 paid in interest.

How to Use This to Save Money

• Make extra principal payments early — they cut interest more than payments made later
• A shorter term means higher payments but dramatically less total interest
• Even 0.5% lower rate on a mortgage saves thousands over 30 years
• Compare APR (annual percentage rate) not just interest rate — APR includes fees