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.
