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How to calculate interest on a loan
Interest is what financial institutions generally charge borrowers to access money. Interest on a loan, such as a car, personal, or home loan, is usually calculated daily based on the unpaid balance.
To calculate your daily interest charge, multiply your loan balance by your annual interest rate and then divide this figure by 365 days (a regular year).
If interest on your loan is usually charged monthly, you can multiply the daily interest amount by the number of days in the month to work out how much interest you're paying.
A hypothetical example:
If you had a home loan balance of $600,000 at 6% p.a., your monthly interest charge would be:
- $600,000 x 0.06 / 365 = $98.63 daily interest (rounded out)
- $98.63 x 31 days (the most common length of a month) = $3,057.53 in interest
You’ll usually need to pay more than just interest alone each period (unless you have an interest-only home loan), as you’ll also need to pay down the amount you borrowed (the principal).
To get an estimation of your repayments, including the total amount of interest you could pay over the life of a loan, you can use Canstar’s calculators for:
If you choose to pay more than the minimum required, or you pay more frequently (like weekly or fortnightly), you can usually save on your loan’s interest.
What can impact how much interest you pay on a loan?
1. The interest rate
A loan’s interest rate can have a big impact on the total amount of interest you pay.
For example, according to Canstar’s mortgage calculator, on a $600,000 loan with an interest rate of 6% p.a. with monthly principal and interest repayments and a loan term of 30 years, the total interest payable will be $695,029 over the life of the loan. This falls to $626,424 with a 5.5% p.a. interest rate.
Interest rates can rise and fall over the life of a variable rate loan due to economic changes and the decisions of your lender. With a fixed rate loan, the rate remains the same for a set period of time, usually between one and five years.
Some of the factors that can determine a loan’s interest rate include:
- Your credit history and credit score
- Whether the interest rate is fixed or variable
- Your loan-to-value ratio (LVR) (for home loans specifically)
- The loan purpose (for example investment property home loans typically have higher rates than those for owner-occupiers)
- Whether the loan is secured or unsecured (if it’s a personal or car loan)
Remember, a loan’s interest rate is different to its comparison rate. While the interest rate tells you how much you’ll be charged to borrow money, it doesn’t include many of the extra costs that can come with a loan. A comparison rate combines interest costs and most fees and charges, and is designed to give you a closer estimate of the total cost of a loan per year.
You can compare a range of home loan, car loan, and personal loan products using Canstar’s comparison tables.
2. The loan amount
The more money you borrow, the more interest you’ll generally pay. This is because interest is charged on your loan balance.
Taking the hypothetical example above, if you were able to take out a $500,000 loan at 6% p.a. rather than $600,000, you would only pay $579,191 in interest over the life of the loan – $115,838 less.
3. The loan term
The longer the term of your loan, the more interest you’ll pay. For example, if you paid off the hypothetical $600,000 loan at 6% p.a. over 25 years rather than 30 years, you’d pay $559,743 in interest.
That’s a potential saving of $135,286 in interest, simply by shortening the loan term. While shorter terms mean higher monthly repayments, they can significantly reduce the total cost of your loan.
4. The repayment frequency
How often you make repayments can also impact the interest you pay. There are two reasons for this.
Firstly, interest is usually calculated on a daily basis. If you make more regular repayments (for example, weekly or fortnightly, instead of monthly), you’ll be paying off the principal amount more frequently, and the balance your interest is calculated on will be lower.
Secondly, and perhaps more effectively, many lenders calculate weekly or fortnightly repayments by dividing the monthly repayment by two or four. However, most months contain more than two fortnights or four weeks. This means a borrower can inadvertently make extra repayments, simply by paying more often.
5. The number of days in a month
Interest is usually calculated daily, so your interest repayment will typically be slightly higher for a 31-day month compared to a 30-day month.
Other factors, such as whether you make additional repayments or if you use a mortgage redraw or offset account, can impact the amount of interest payable. Making interest-only repayments for a period of time will also generally increase the amount of interest you pay in the long run, as you won’t be paying down the principal amount during this time.
How to get the best loan interest rates
To increase your chances of getting a favourable interest rate from a lender, there are a few things you can think about doing:
- Improve your credit score: Lenders – particularly those offering car and personal loans – will generally offer more competitive rates for borrowers with higher credit scores. You can check your credit score for free with Canstar and via the Canstar App.
- Reduce your DTI or LVR: A debt-to-income (DTI) ratio compares the amount of debt you have to your overall income, while an LVR weighs how much you’re borrowing against the value of the asset you’re buying. If you have a large amount of debt or you’re borrowing a hefty portion of the purchase price of a house or car, a lender may see you as a more risky borrower. This may impact the interest rate it offers you.
- Compare different lenders and their products: It’s often worth comparing loans from different lenders to find one that suits your needs and situation best. You can compare a range of different lenders and products using Canstar’s comparison tables.
Budgeting and managing your finances carefully may also allow you to cut back on unnecessary expenses and use the money saved to reduce your loan’s balance (if your loan allows you to make extra repayments). This can reduce the amount of interest you pay overall.
Depending on your personal circumstances and the type of loan you’re looking for, you may also like to view Canstar’s Award winners for:
What is an amortisation schedule?
Since interest is calculated daily based on a loan’s outstanding balance, the amount of interest you pay will shrink every time you repay some of the debt, but your repayments will stay the same (assuming your interest rate doesn't change). This means as you pay down your loan balance over time less of each repayment will go toward interest and more will be used to pay off the principal.
How much of your repayments go towards interest compared to the principal balance each year may be outlined in your amortisation schedule. Amortisation on a monthly basis can be calculated by multiplying the loan balance by the interest rate and dividing the result by 12 to get the monthly interest charged. Then, subtract that from the monthly payment. Whatever remains goes toward the principal.
If you do this each month, you’ll notice that as your principal balance reduces, less of your repayment goes to interest and more goes toward paying off the loan.
To make things easier, our loan repayment calculators (listed above) also provide an amortisation schedule in the form of a chart or table. Though, shifts in your interest rate may impact your amortisation schedule.
