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How to Calculate Interest on a Loan?

January 17, 2024 • 1965 views

If you want to buy a new home, starting a new business or pursue higher education, accomplishing these dreams may require financial support. One of the best ways to get the funds you need is to apply for a loan. But you must know that loans come with interest. It is the amount you pay the lender for lending you the money when needed.   

Interest calculation depends on factors like the loan amount, interest rate, and loan term. Also, the interest levied by the lenders are generally of two types – simple interest and compound interest.  Each of these interest types are computed with different methods. As a borrower, knowing how the interest on your loan is calculated is paramount to make informed borrowing decision.

How to Calculate Interest on a Loan?

There are two primary methods for calculating loan interest as mentioned below:

  • Simple Interest: In this method, the interest on loan is calculated based on the initial loan amount (principal) and the interest rate. It's straightforward and doesn't change over time.
  • Compound Interest: With compound interest, you not only pay interest on the principal but also on any previously accrued interest. This can lead to higher total repayments, especially in longer-term loans. 

Also Read - Fixed Interest Rate - Meaning, Pros & Cons, and How Does It Work?

Basic Loan Interest Calculation

Understanding how to calculate basic loan interest involves the below methods:

  • Simple Interest: To find simple interest, you'll need to know three things: the amount you borrowed (the principal), the annual interest rate (like a percentage), and how long you'll be borrowing the money. For example, if you borrow Rs 10,000 at an annual interest rate of 5% for three years, you'd calculate it like this: Rs 10,000 x 5% x 3 / 100 = Rs 1,500. So, the total interest payable would be Rs 1,500.
  • Compound Interest: This one's more complex. It's often used for long-term loans like mortgages. You'll need specialised calculators or computer programs to calculate it accurately.

Practical Examples: Calculating Interest on Different Loans:

  • Calculating Interest on Personal Loans: These usually use simple interest. Just knowing the interest rate, the loan amount, and how long you're borrowing helps you find your total interest cost.
  • Calculating Interest on Mortgage Loans: Mortgages often involve compound interest due to their long terms. To figure out mortgage interest accurately, you'll need to consider how often the interest gets added up and use specialized tools.
  • Calculating Interest on Business Loans: These can be simple or compound interest, depending on the loan terms. Knowing the details of your business loan is vital to figuring out interest correctly.

Also Read - How to Calculate Interest Rate Per Month?

To Conclude

Understanding how to calculate interest on a loan is essential for responsible financial management. It allows you to evaluate the actual borrowing cost and make informed decisions. When considering loans, choosing a reliable lender is equally important.

You can apply for a loan with Poonawalla Fincorp, one of the leading NBFCs in India, and enjoy a range of benefits, including competitive interest, quick approval, and minimum documentation.

 

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Disclaimer

We take utmost care to provide information based on internal data and reliable sources. However, this article and associated web pages provide generic information for reference purposes only. Readers must make an informed decision by reviewing the products offered and the terms and conditions. Loan disbursal is at the sole discretion of Poonawalla Fincorp.
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poonawalla fincorp team

Poonawalla Fincorp Team

Our team of expert writers and editors are passionate about providing authentic and valuable information on finance. Our aim is to simplify financial and finance-related concepts. We strive to help our readers become more aware and empowered to make informed financial decisions.

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