What is Interest on a Personal Loan?

Repayment of loans is made in two parts – the principal and the interest. Interest is a separate component of a loan that is levied as a charge by the loan provider. It is paid periodically as a percentage of the remaining loan amount.

When you borrow a personal loan, it is important to calculate for yourself the interest amount that you are paying on a monthly basis. This can reveal your total interest cost over the total time duration of the loan. We will do this very exercise using a simple example in this article.

What is Interest Rate?

Interest rate is typically denoted as Annual Percentage Rate (APR). It signifies the amount that you pay to the lender every year on the outstanding loan amount.

Factors that Influence Interest Rate on Personal Loans

The central bank generally sets the interest rate. However, market conditions also influence the on-going interest rates for different products. For personal loans, apart from these, there are various other factors also that will influence the interest rate you get. These factors include age, stability in income, whether you are salaried or self-employed, work experience – total as well as in the current organization, loan tenure, credit score, existing borrowings, and repayment capacity, among other things.

Other technical factors relating to the loan that impact the interest rate you are offered include:

Principal Amount

You can negotiate better with the lender in case you need a bigger amount and have a good credit score.

Loan Term

The tenure of the loan will ultimately define how much interest you end up paying over the years.

Repayment Schedule

More frequent repayment would mean constantly decreasing burden of interest.

How is Interest Calculated on Personal Loan?

Here is the basic formula:

Interest = Loan Principal*Interest Rate

Suppose Rohan takes a personal loan of INR 5 Lakhs at an interest rate of 12% per annum to be paid back in 5 years, the interest will be calculated as:

(5,00,000*0.12/12)=5,000

The total EMI (Interest + Principal) on this is calculated by the formula as described here, which comes out to INR 11,122.

After applying the EMI calculation formula, first month calculation looks something like this:

Month Loan Balance EMI Interest Paid Principal Paid New Balance
             1         5,00,000    11,122               5,000                   6,122       4,93,878

 

Now for the next month, the interest will be calculated on the new balance which is calculated as:

Loan Balance – Principal Paid

In this case, in order to determine the interest, you will have to use INR 4,93,878 as the loan amount.

From here, you can create your own interest calculator in Excel for the subsequent months, which would be something like:

Month Loan Balance EMI Interest Paid Principal Paid New Balance
             2         4,93,878    11,122               4,939                   6,183       4,87,695
             3         4,87,695    11,122               4,877                   6,245       4,81,450
             4         4,81,450    11,122               4,814                   6,308       4,75,142
             5         4,75,142    11,122               4,751                   6,371       4,68,772
             6         4,68,772    11,122               4,688                   6,434       4,62,337
             7         4,62,337    11,122               4,623                   6,499       4,55,839
             8         4,55,839    11,122               4,558                   6,564       4,49,275
             9         4,49,275    11,122               4,493                   6,629       4,42,646
           10         4,42,646    11,122               4,426                   6,696       4,35,950
           11         4,35,950    11,122               4,360                   6,762       4,29,188
           12         4,29,188    11,122               4,292                   6,830       4,22,358

 

How is Total Interest Calculated?

Adding up the interest on all 12 months, you can determine the total interest paid on your personal loan for the first year, which in this case would be INR 55,822.

Now in order to determine the total interest that Rohan would end up paying over the course of 5 years can be determined by stretching the same inputted formulae in excel to 60 months. The result for the last year (5th year in this case) would be something like:

Month Loan Balance EMI Interest Paid Principal Paid New Balance
          49         1,25,182     11,122               1,252                   9,870       1,15,311
           50         1,15,311     11,122               1,153                   9,969       1,05,342
           51         1,05,342     11,122               1,053                 10,069          95,273
           52            95,273     11,122                  953                 10,169          85,104
           53            85,104     11,122                  851                 10,271          74,833
           54            74,833     11,122                  748                 10,374          64,459
           55            64,459     11,122                  645                 10,478          53,981
           56            53,981     11,122                  540                 10,582          43,399
           57            43,399     11,122                  434                 10,688          32,711
           58            32,711     11,122                  327                 10,795          21,915
           59            21,915     11,122                  219                 10,903          11,012
           60            11,012     11,122                  110                 11,012                    0

 

The complete dues on interest as well as principal are paid in the 60th month thereby closing the loan. Now if we add up the totals, it reveals to us something like this:

Total EMI = INR 6,67,333

Total Principal Paid = INR 5,00,000

Total Interest Paid = 1,67,333

The total interest paid is basically 33% of the principal amount that you had borrowed.

Keep your Calculations Handy for Instant Personal Loans

Now that you know how the total interest amount is calculated for a personal loan, it would be a good idea to have your calculations handy when you shortlist between the best offers made to you. There are various other loan interest calculators, personal loan calculators and EMI calculators online that you can also use. In this digital age, personal loans are hardly a few clicks away. With PaySense, you can secure easy personal loans of up to INR 2 Lakhs hassle-free and the loan amount gets disbursed to your account in just a few hours. While we revolutionize the lending market, you can surely enjoy the benefits of securing a loan from the comfort of your home.

Shweta Joshi

More Posts