How to calculate monthly payment on a loan formula?

Calculating Monthly Loan Payments: A Formulaic Approach

When taking out a loan, it’s essential to understand the intricacies of monthly payments to ensure financial planning and budgeting. The formula below provides a comprehensive method for calculating these payments:

Formula:

M = P * [i * (1 + i)^n] / [(1 + i)^n - 1]

Variables:

• M: Monthly payment
• P: Loan principal (amount borrowed)
• i: Monthly interest rate (annual rate divided by 12)
• n: Total number of payments

Steps:

1. Determine the loan principal (P), which represents the total amount borrowed.

2. Calculate the monthly interest rate (i) by dividing the annual interest rate by 12. For example, if the annual rate is 6%, the monthly rate would be 0.06 / 12 = 0.005.

3. Determine the total number of payments (n) based on the loan term. For example, a 10-year loan with monthly payments would have n = 10 * 12 = 120.

4. Plug the values of P, i, and n into the formula:

M = P * [i * (1 + i)^n] / [(1 + i)^n - 1]

5. Calculate the result, which represents the fixed monthly payment.

Example:

Consider a loan of $20,000 with a 5% annual interest rate and a repayment period of 5 years.

• Loan principal (P) = $20,000
• Monthly interest rate (i) = 5% / 12 = 0.00417
• Total number of payments (n) = 5 * 12 = 60

Plugging these values into the formula:

M = 20000 * [0.00417 * (1 + 0.00417)^60] / [(1 + 0.00417)^60 - 1]

M = 416.07

Therefore, the monthly payment for this loan would be $416.07.

Significance:

Understanding how to calculate monthly loan payments empowers borrowers with the ability to make informed financial decisions. By utilizing this formula, they can:

• Estimate the total cost of the loan, including interest payments.
• Compare different loan options and select the most suitable one.
• Determine the affordability of the loan based on their monthly budget.
• Plan for the repayment period and adjust their finances accordingly.