Interest is a major concern … Yes …when we take out a loan, whether it’s a car loan, home loan or credit card, we’ll have to pay back both the amount we borrowed and interest on top of it. But what do we mean by that?
Well, mostly, interest is a fee you pay for using someone else’s (usually the bank’s) money. It is how lenders make a profit from giving out loans – after all, they’re not in it out of the goodness of their hearts.
Usually, the repayments you make on loan will be made up of two parts: the part that reduces your balance to pay off your loan, and the role that thoroughly covers it.
Factors that affect how much interest we pay
Principal Amount Taken
This is the amount we’re borrowing. But it’s not as simple to decide how much we want – we should be focusing on how much you can realistically afford to pay back. To work it out, consider our budget on all levels – yearly, monthly, and weekly – and think about any life changes we might encounter.
How long will we be repaying our loan?
Shorter loan terms would usually mean higher repayments, but less amount in the long run, while longer times will lower monthly repayments. But, it will cost more in amount over the entire life of the loan.
Repayment Schedule
On many loans, we’ll have the option to make repayments weekly, fortnightly, or monthly. Which one we choose will depend on our budgeting style.
More repayments mean less interest because of the compounding effects so that those weekly repayments will save us some money. But before we commit to a weekly repayment schedule, make sure that our budget can meet it!
Repayment of Amount
When we make our repayment, not all of it goes to paying off our loan, as such. Any amount will go towards funding the interest first, and afterward, what’s left chips away at our loan principal. Because the amount we pay depends on our principal’s, we’ll need to know what amount we’re making in repayments to calculate ongoing interest costs.
Rate of Interest
When calculating interest on our loan, remember to use the annual rate and not the comparison rate to get accurate numbers. The comparison rate takes into account fees, charges, and interest, so if we use it, we will get higher than we should.
Calculating interest on Loaned Car, Personal or Home Loan
These loans are called amortizing loans – that means that the mathematical whizzes at our bank have worked them out so that we pay a set amount each month, and at the end of our loan term, we will have paid off interest as well as principal.
We can use an interest calculator to work out how much interest you’re paying all up, or, if you’d instead do it by hand, here’s how:
- Divide the rate by the number of payments we will make in the year, and rates are expressed annually. So, for example, if we’re making monthly payments, divide by 12.
- Multiply it by the balance of our loan, which will be our whole principal amount for the first payment.
- This gives us the amount of interest we pay for the first month.
- For example, on a personal loan of Rs.30,000 over 6 years at 8.40% p.a. and making monthly payments:
- Because we’ve begun to pay off our principal and work out the interest we pay in the following months, we need first to calculate our new balance.
- Minus the interest that we calculated from the amount we repaid. This gives us the amount that we have paid off the principal.
- Take the amount away from the original principal to find the new balance of our loan.
To access ongoing payments, the easiest way is to break it up into a table. So using the above example, our calculations may look like the following table:
| Month | Starting Balance | Repayment | Interest Paid | Principal Paid | New Balance |
| 1 | Rs.30,000 | Rs.532 | Rs.210 | Rs.322 | Rs.29,678 |
| 2 | Rs.29,678 | Rs.532 | Rs.207.75 | Rs.324.25 | Rs.29,353.75 |
| 3 | Rs.29,353.75 | Rs.532 | Rs.205.48 | Rs.326.52 | Rs.29,027.23 |
| 4 | Rs.29,027.23 | Rs.532 | Rs.203.19 | Rs.328.81 | Rs.28,698.42 |
| 5 | Rs.28,698.42 | Rs.532 | Rs.200.89 | Rs.331.11 | Rs.28,367.31 |
Keeping in mind that doing the calculations on our means discrepancies due to rounding and human error, this should give you a good idea of what we’re paying in interest each month.
Interest-only Loans
Are they taking out a home loan? We may have the option to choose between a principal and interest loan or an interest-only loan.
If we choose to take out an interest-only loan, your total monthly payment will be in interest, as the name suggests. We won’t be chipping away at our principal amount, which means the amount of interest we pay won’t change. In the above example, we’d spend the only Rs.210 in interest each month, and then at the end of the 6 years, we’d have to pay a lump sum of Rs.30,000 in full.
Calculating interest on a Credit Card
It is a good idea to think of using a credit card as taking out a loan – it’s money that is not ours, we are paying to use it, and we should pay it back as soon as we can.
For the most part, working out how much we pay on our credit card balance works much like any other loan. The main differences are:
Your necessary repayment is a minimum amount set by our credit card company. It might be a set rupee amount, or it might be a percentage of our balance. It is best to pay more than the minimum amount because it often doesn’t cover the cost of interest. Paying only the minimum is how we wind up with a massive credit card debt.
If we make purchases on our card before paying off previous amounts, it will be added to our balance, and we’ll pay it on the whole lot. This will change our minimum payment amount as well if the minimum payment is based on a percentage of our balance.
It is a good idea always to pay off as much of our credit card balance as we can, as early as we can – that way, we avoid getting hit by high rates!
When calculating our interest, remember to use the right amount for our repayment value and add extra purchases to our balance. The above method should work to calculate our interest.