Loan Repayment Calculator
15 Jan 2021
- Loan Repayment Calculator
- How Are Loan Repayments Calculated?
- Fixed Rate Vs Variable Rate Loans
- Why Is Interest Charged On Loans?
- Secured Loan Repayments Vs Unsecured Loan Repayments
- Secured Loans Vs Mortgages
- Why Is It Important To Calculate Loan Repayments?
- How Does The Length Of A Loan Impact The Size Of Each Repayment?
Use this loan repayment calculator to work out the approximate monthly repayments you will need to make on a personal loan or mortgage. You will find that the loan repayment total will rarely match the figure provided by a bank as they may apply an administration fee for example, that is included or excluded from the APR they are quoting; first payment is sometimes larger than subsequent payments; the interest rate actually offered can be different to advertised rates depending on your circumstances; discounts may also apply.
How Are Loan Repayments Calculated?
When you take out a loan from a lender you make a commitment to repay not only the initial loan amount but also an additional amount known as interest. Lenders offer their loans at an interest rate that is either fixed for the duration of the loan or subject to fluctuations, either up or down, usually linked tobthe interest rate set by the Bank of England. A loan repayment is calculated by multiplying the loan by the interest rate.
When repaying a loan, if the interest amount is repaid each period, such as each month, but no more than the interest amount then nothing is being repaid against the original loan amount. Therefore a borrower could make interest payment for 1 year, 5 years or 20 years and the amount owed would never go down.
If a repayment less than the calculated interest is made then the difference between the calculated interest and the repaid interest is added to the loan amount. Each time such an underpayment takes place the loan amount, or debt, is increasing. Repayments can quickly become unmanageable in this scenario because the interest calculation for the next period will be based on a larger loan amount meaning the next interest payment will be larger than the last. A vicious cycle can ensue where loan repayments become more and more difficult over time.
When a loan repayment exceeds the calculated interest then not only is the interest for the current payment period being paid off but so too is some of the initial loan amount being paid off. In this scenario the loan amount becomes smaller in each period and the interest calculated for the subsequent period will be lower creating a virtuous cycle where loan repayments become smaller over time, provided the interest rate remains constant.
Fixed Rate vs Variable Rate Loans
Interest rates can fluctuate over time. If wages, consumers goods prices and house prices are going up quickly then it is likely that the Bank of England will will raise interest rates to prevent the economy from overheating. On the other hand, interest rates might be lowered to stimulate the economy.
When taking out a loan a borrower will use the current interest rate to calculate their expected loan repayments. Over the course of the loan, if interest rates rise then so will loan repayments. This uncertainty creates a risk that loan repayments become unaffordable if interest rates rise too much.
If a borrower is worried by the risk of their loan repayments becoming unaffordable they may choose to take out a loan that has a fixed interest rate. This shifts the risk of an interest rate rise away from the borrower and towards the lender. It is therefore typical that the lender will charge a higher rate of interest on fixed rate loans than on variable rate loans.
A borrower who is not so concerned about their loan repayments increasing due to an interest rate rise may prefer the cheaper variable rate loan on day one, accepting that their repayments might increase at a later date. Other borrowers might be happy to gamble that interests will fall over time, therefore taking out a variable rate loan in the hooe that their interest payments will fall over time due to lower interest rates.
Why Is Interest Charged On Loans?
When you go to the supermarket you can only take your chosen groceries home if you pay for them. The amount of money you pay has to cover costs such as farming, transport, property costs, staff costs and more as well as making a profit for shareholders.
Just like the supermarket, a lender is a business that has property costs, staff costs, IT costs and more and shareholders who demand a profit. When providing a loan the lender charges an interest rate in order to generate interest payments. Those interest payments can be considered as the cost of the loan, which, just like the cost of groceries, pay for the lender's running costs and create shareholder value.
Secured Loan Repayments vs Unsecured Loan Repayments
A secured loan is one that is secured against collateral put up by the borrower, such as a house or a car. If the borrower is unable to make their loan repayments then the lender has a claim against the asset that was pit up as collateral.
An unsecured loan does not require collateral for the loan to be secured against. Consequently risk is shifted away from the borrower towards the lender, since in the case of the borrower being unable to make their loan repayment the lender has no claim on an asset to compensate their loss.
Unsecured loans therefore tend to have higher interest rates resulting in higher loan repayments.
Secured Loans vs Mortgages
A mortgage is a particular type of secured loan that is for the sole purpose of purchasing property and tends to be a long term loan, such as 25 years.
Some mortgages also offer more repayment options than other secured loans. One option is to calculate repayments based on repaying both the capital and interest with each monthly repayment. Another options is to calculate repayments based on repaying only the interest.
With the interest only repayment option it is important to understand that at the end of the mortgage the borrower will have repaid substantial amounts in interest but will still owe entire value of the initial loan amount. Often some form of investment vehicle will be setup alongside an interest only mortgage with the intention of growing an investment that is worth at least the same as the original loan amount at the end of the mortgage so that it can be used to repay the loan at the end of the mortgage.
Why Is It Important To Calculate Loan Repayments?
Using a loan repayment calculator allows a borrower to understand how affordable a loan might be for them. By experimenting with different inputs to the calculator a borrower can check whether their loan remains affordable if interest rates go, or whether taking a loan over more years makes the loan more affordable.
These checks are important because when a borrower cannot afford their loan repayments they risk losing assets against which a loan is secured, such as a house or car as well as incurring damage to their credit rating, which can hinder their ability to enter into credit agreements in the future.
How Does The Length Of A Loan Impact The Size Of Each Repayment?
Loans are usually taken over a number of years with monthly repayments. Therefore a loan taken over 5 years will have 60 repayments since there are 12 months per year. A 10 year loan would have 120 monthly repayments.
Since the loan amount to be repaid is spread over more monthly repayments with the longer term loan, each repayment is smaller with the longer term loan.
However, the longer term loan will incur more interest because the loan is being paid back more slowly. The longer term loan therefore costs less each month, but it costs more overall, all else being equal.
Have a question about our this calculator? See our list of frequently asked questions below.
- How are loan repayments calculated?
- Loan repayments are calculated by dividing the amount of loan that is outstanding by the number of repayments that are left to make, plus the interest incurred in the current payment period.
- How are loan interest payments calculated?
- Interest amount = Loan amount * Interest rate.
- How does the length of a loan impact the size of each repayment?
- Each repayment is smaller because the loan amount is spread over more repayment periods.