How to Calculate Payments on a Loan

A lot of the time, we are given a couple variables and we want to calculate the payments on a loan. For example, you are trying to finance a $10,000 car at a 12% interest rate for 5 years. All you want to find out is how much your monthly payment is going to be and whether or not you can afford that payment. Just a heads up - you will need a calculator to figure out these payments. Since you are probably on a computer right now, you can use the calculator on your computer, or you can use excel.

Lets use the example above and try to calculate out your monthly payment. First, let’s set some terms. PV (Present Value) of the loan is going to be $10,000. Your interest rate per year is going to be .12. However, since we are trying to calculate out MONTHLY payments, we are going to want to turn this 12% per year into a monthly rate. This is as simple as dividing .12 by 12 which gives you .01 or 1%. Finally, we are going to want to define our number of payments, n. We know that it will be 5 years, but we need to convert that into months. Simple as multiplying 5 by 12 which gives you 60 months.

Ok, so here are our variables:

Total number of payments: n=60

Interest: i=0.01

Present Value: pv=10000

The easiest way to calculate payments is to use a spreadsheet on your computer like excel. Open up the program, select a cell and type in the following exactly (without the quotes): "=PMT(0.01,60,10000)". Hit enter. This will automatically calculate out your monthly payment of "-$222.44". This is what your monthly payment on your car loan should be, given those exact variables. I am sure that the loan you are trying to calculate payments on has different variables, so here is the equation using variables instead of values: "=PMT(i,n,pv)". To calculate payments on your loan, just replace the i with interest, n with number of payments and pv with the total loan amount.

Using excel to figure this out is by far the easiest way. Just plug your variables in and hit enter and you are finished. If you are deathly afraid of excel, you can use the old-fashioned formula. Take a look at it and maybe you might want to give excel a shot first:

Monthly Payment = (pv) * (i/(1-(1+i)^(-n)))

Ok, let’s solve this using our example:

Monthly Payment = (10000) * (.01/(1-(1.01)^(-60)))

Monthly Payment = (10000) * (.01/(1-0.55045))

Monthly Payment = (10000) * (.01/.44955)

Monthly Payment = (10000) * (0.022244)

Monthly Payment = $222.44

So we get the same answer of your monthly payment being $222.44. Piece of cake!

What do we learn from this? You are buying a car for $10k and you only have to make monthly payments of $222.44 for five years to pay the thing off. Doesn't sound that unreasonable? Well if we add up all the monthly payments, we find that you ended up paying a total of $13,346 for a $10,000 car. And what is your car worth now? $3,000? So by the time you pay the car off, you are out a total of over ten grand!

What would have happened if the financing option had not been available to you? You might have bought something a little more economical, say a car worth $2500. Even if your car is now worth $500 now, you are still only out two grand instead of being out over ten grand!

Keep this in mind next time you calculate payments on your loan!