What is interest rate and how is the loan installment calculated
Continuing my last post, here I’d like to present you some basic information about the mechanism of calculating loan installments. I hope it will be helpful for people who did not have any experience with loans and want to get a loan in the near future.
The interest rate is the main cost of borrowing. The longer the repayment period of the loan, the more cumulative interest income the borrower will pay to the bank.
The interest on the loan is always given on an annual basis. However, installments are paid monthly. Every month the bank determines how much unpaid capital remains, and from this capital the interest is calculated, taking into account the annual interest rate and the number of days in the month (for example if in a given month there are 31 days, interest will be higher than in the 28 or 30 days month). For the calculation it is usually assumed that a year has 365 days.
When we have a loan repaid in equal installments, the amount of installment will include an amount of calculated interest, and the remainder will be a repayment of capital. It is easy to calculate that in the shorter months (in February and 30-day months) the share of the capital in the installment will be higher than in the longer months (containing 31 days).
In the case of decreasing installments, the amount of interest is added to a fixed amount of capital, repayable on a monthly basis.
Below we present an example of calculation of installment for the loan, in which USD 100.000 of capital remains to be repaid. The interest on the loan is 5%, and interest is calculated for January (31-day month).
Interest = USD 100,000 * 0.05 * 31 / 365 = USD 424.66
In this case, to repay the loan in the system of equal installments over 20 years, the monthly installment amounts to 659.96 (you can calculate the installment in the loan calculator). Thus, the share of the capital in the January installment will be:
USD 659.96 - USD 424.66 = USD 235.30
Tags: installment, interest rate, loans
Loans and Banking | admin | 
November 11, 2008 8:02 pm