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Understanding how a loan payment is calculated helps you know, before you sign, how much you'll pay in total. The monthly payment is determined by the amortization formula, which combines the principal borrowed, the interest rate, and the term.

What does the formula account for?

• The principal: how much you borrow.
• The interest rate: how much the loan costs each year.
• The term: over how many months you'll repay it.

With these inputs, you can calculate how much of each monthly payment goes to interest and how much to principal.

How payments change over time

In an amortized loan, the payments are usually equal, but their makeup changes: at first you pay more interest and little principal; over time, the proportion reverses. That's why making extra payments early significantly reduces the total interest.

Use a calculator before deciding

Before accepting a loan, use an amortization calculator to compare scenarios: different terms and rates can dramatically change the total cost. A longer term lowers the monthly payment but usually increases the total interest you pay.