The terms and conditions of a loan agreement clearly state the amount and number of installment payments required for repayment, but that happens at the end of the application and approval process. Using a loan payment calculator prior to that helps determine which lender to choose and makes it simpler to create a budget to meet their terms.
How a loan payment calculator works
There are three variables required to use a loan payment calculator. The first two are the amount of the loan and the annual percentage rate (APR). The third is the number of years it will take to pay the loan off. This is known as the “loan term.” Most calculators allow the user to compare multiple loan terms for budgeting purposes.
The objective is to find out how much the lender will require in monthly installment payments. Enter the loan amount, APR, and the term if the calculator requires it. Some loan payment calculators will automatically give the user 24-month, 36-month, 48-month, and 60-month output, so only the loan amount and APR are required.
It’s important to understand that APR is not the same as the interest rate. The APR includes interest and fees, so language is important. Many lenders advertise low-interest rates, and borrowers are surprised when they pay more than expected. Compare the APRs because that’s where lenders are more easily differentiated from one another.
Understanding APR, interest, and amortization
The annual percentage rate includes interest, fees, and other charges from the lender, so it will always be higher than the interest rate. During the life of the loan, those fees will remain constant. Interest payments may be “front-loaded,” with the bulk of them coming in the early months and years of the agreement. This is known as “amortization.”
A loan payment calculator won’t display an amortization schedule because each lender treats this differently. It should, however, show the relationship between interest payments and payments applied to principal during the life of the loan. Users can see the total amount they’ll pay in interest over the life of the loan and how changing the term will affect that.
Opting for a shorter term to save on total interest payments will not change the amortization schedule. That means that borrowers will still pay mostly interest in the early stages of the loan. That’s mostly irrelevant with unsecured personal loans, but it makes a big difference with mortgage payments when the borrower is trying to build equity in their home.
The Bottom Line
Calculating the payment amount is important. Loan payment calculators should be classified as an essential tool when shopping and applying for any type of loan. It’s important to know the amount of monthly installment payments and the effects of interest and APR on the loan. The “total amount paid” tells the borrower exactly how much it will cost to borrow the amount of money they need.
Another factor to consider is that knowing the monthly payment amount before applying for a loan gives the borrower the ability to create a budget to make those payments. Waiting for that information until the loan application has been processed and approved could cause financial unmanageability. The loan payment calculator can help prevent that.