How the monthly payment is worked out
Fixed-rate loans are amortized: you pay the same amount every month, and each payment covers that month's interest plus part of the balance. The payment is:
M = P × r(1 + r)n ÷ ((1 + r)n − 1)
- M = monthly payment
- P = amount borrowed
- r = yearly interest rate ÷ 12, as a decimal
- n = number of monthly payments
Example: borrowing $25,000 at 8.5% for 5 years (60 payments) costs $512.91 a month, or $5,775 in interest over the life of the loan.
What changes the total cost of a loan
Three numbers decide what you pay: the amount, the rate and the term. The term is the one people underestimate. A longer term lowers the monthly payment, but you pay interest for more months, so the total grows. The same $25,000 at 8.5%:
- 3 years: $789.19 a month, $3,411 in interest.
- 5 years: $512.91 a month, $5,775 in interest.
- 7 years: $395.91 a month, $8,257 in interest.
Before you sign
- Ask for the APR, not only the interest rate. The APR includes fees, so it shows the true yearly cost.
- Check for early repayment fees. Without them, extra payments are one of the safest ways to save money.
- Compare offers by total cost, not by monthly payment. The lowest monthly payment is often the most expensive loan.