What Method Do Creditors Use to Calculate Interest on Your Mortgage and Auto Loans?

Do you have an auto loan? What about a mortgage loan? Have you ever wondered how your creditors calculate the interest on your loans? When you make a payment part of the payment goes to interest and a part of the payment goes towards reducing your principal balance. There is a formula you can use to see how this works.

Term and conditions

The first things you will need are the terms and conditions of your loan. For example if you have a loan balance of $25,000 with an interest rate of 8 percent and monthly payments of $450, you can calculate the break down of principal and interest for your payment. First let's calculate the interest portion. Take the interest rate .08 and divide it by 360 days, ( 360 is assuming every month has 30 days), and then multiply the difference times the balance, $25,000, and then multiply times the number of days in the billing cycle, which is usually 30 days. With these figures we get $166.65 for the interest.

Principal payment

Once you have the interest payment you can easily calculate your principal payment. Subtract the interest figure of $166.65 from the monthly payment of $450. You should get $283.35 as your principal payment. So when your payment is applied your balance of $25,000 is reduced by $283.35 making the new balance $24,716.65. Next month you do the same calculation using the new balance of $24,716.65.But let's say that payment was received on March 15. Now you send in another payment which is received on March 30. When you do your new calculation you will use 15 days as the number of days in the billing cycle instead of 30 days. You use 15 because you are using the number of days since the last payment, (March 15), to the day the new payment is received, (March 30), which is 15 days.

New calculation

So with the new information let's do the new calculation. Divide .08 by 360 and then multiply by 15 days and then multiply by the new balance of $24,716.65. The interest figure using the new figures will now be $82.38. The principal payment will be $367.62. Subtract this amount from your balance of $24716.65 and the new balance is $24,349.03. You can use this formula every time you make a payment, even a large payment. Just remember to use the number of days from the last payment to the new payment. It may not be 30 days, depending on when you pay.

Reference

http://guides.yellow.co.nz.php5-2.dfw1-1.websitetestlink.com/investment-and-finance/finance/calculating-interest-on-a-loan/