Interest determines how much extra you pay the lender beyond the principal amount. You can calculate the interest payable on a loan using the applicable interest rate, loan amount and repayment tenure. Understanding how loan interest is calculated can help you compare loan offers, estimate your total repayment and choose a loan that fits your budget. This guide will tell you how to calculate your EMI and total interest on a loan.
What Is a Loan Interest Rate?
A loan interest rate is the percentage of the amount you borrow that a lender charges you for using the money. It is expressed as a percentage rate per annum. This interest rate affects your total borrowing cost and the EMI you pay during the loan tenure. A lower interest rate means you pay less interest over the life of the loan, while a higher rate increases the total cost of borrowing.
Terms You Must Know Before Calculating Interest
To calculate the interest on a loan, knowledge of these basic terms can help:
- Principal: The original amount you borrow from the lender
- Interest rate: The percentage charged by the lender on the borrowed amount, usually per annum
- Loan tenure: The period over which you repay the loan, in months or years
- EMI: The fixed amount you pay to the lender each month towards the principal and interest
- Outstanding principal: The portion of the original loan amount that is still left to repay at a given point
- Total interest: The total amount of interest you pay over the entire loan tenure
- Total repayment: The total amount you pay the lender, including both the principal and interest
- Reducing balance: A method where interest is calculated on the outstanding principal, which decreases as you make repayments.
How to Calculate Interest Rate on a Loan
You can calculate a loan interest rate depending on how interest is charged. For a simple-interest loan, you can calculate the interest rate if you know the principal amount, total interest paid and loan tenure. For EMI-based loans that use the reducing-balance method, the calculation is different because interest is charged on the outstanding principal.
If your loan uses simple interest, you can calculate the interest rate using the following formula:
Simple Interest = (P × R × T) / 100
To find the interest rate, rearrange the formula:
R = (SI × 100) / (P × T)
Where:
P = Principal or loan amount
R = Annual interest rate
T = Loan tenure in years
SI = Total simple interest paid
For example, if you borrow ₹1,00,000 and pay ₹15,000 as interest over 1 year:
R = (₹15,000 × 100) / (₹1,00,000 × 1) = 15% p.a.
Reducing Balance Method
For loans that use the reducing balance method, interest is calculated on the outstanding principal rather than the original loan amount. As you repay the principal through your EMIs, the outstanding balance reduces, so the interest charged also reduces.
This EMI formula can be used to calculate the EMI when the loan amount, interest rate and tenure are known:
EMI = [P × r × (1 + r)ⁿ] / [(1 + r)ⁿ − 1]
Where:
P = Loan principal
r = Monthly interest rate
n = Total number of monthly instalments
Example: If you take a ₹2 lakh loan at 12% p.a. for 2 years. In the first month, interest will be calculated on the full outstanding principal of ₹2 lakh. After you make the first EMI, a portion of the payment will g towards repaying the principal. If the outstanding principal falls to ₹1.93 lakh after the payment, the next month's interest will be calculated on ₹1.93 lakh instead of ₹2 lakh. As you continue making repayments, the outstanding principal will keep on reducing, and so will the interest charged on it.
How Does the Interest Rate Affect EMI and Total Interest?
The interest rate affects both your monthly EMI and the total cost of your loan. If the loan amount and tenure remain the same, a higher interest rate would mean a higher EMI and more interest paid over the loan tenure. A lower rate can reduce both your monthly repayment and interest cost.
For example, if you take a ₹5 lakh loan for 5 years, the EMI and total interest payable will be lower at 10% p.a. than at 12% p.a. Even though you borrow the same amount and repay it over the same period, the higher rate will increase the amount you pay towards interest each month and over the entire tenure.
This is why it is important to compare the interest rates offered by different lenders before choosing a loan. However, the interest rate should not be the only factor you consider. Also check the processing fee, prepayment or foreclosure charges, other fees and the total repayment amount to understand the total cost of the loan.
What are the Types of Loan Interest Rates and Calculation Methods?
The way the interest rate is charged on a loan depends on how the interest is calculated, whether the rate charges and how the outstanding balance is treated:
How Interest is Calculated
- Simple Interest: Interest here is calculated only on the principal amount for the specified period. Works well for short-term loans and keeps repayment predictable, with no additional compounding.
- Compound Interest: Interest is charged on the principal and accumulated interest, depending on the compounding frequency. Increases total repayment, but is common in long-term loans and credit products.
Whether the Interest Rate Changes
- Fixed Interest Rate: The rate stays constant throughout the loan tenure. EMI remains stable, making it easier to plan monthly expenses without fluctuations.
- Floating Interest Rate: The rate changes based on market benchmarks and the lender's spread. This can cause your EMI or loan tenure to change, offering savings when rates fall but increasing costs when rates rise.
How the Interest is Applied to the Outstanding Loan
- Reducing Balance Interest: Interest is calculated on the remaining principal after every EMI payment, so the interest amount falls as you repay the loan.
Step-by-Step Process to Calculate Interest
To calculate the total interest rate on a loan, you will first need to know the amount borrowed, the total interest paid, and the loan tenure. The calculation method depends on how the lender charges interest. For a simple-interest loan, you can follow the given steps:
- Step 1: Find your loan amount: Check the original principal amount disbursed by the lender.
- Step 2: Check your total interest paid and loan tenure: Look at your loan agreement or repayment schedule for the total interest charged and the loan tenure in years.
- Step 3: Check how interest is calculated: Find out whether the lender uses simple interest, reducing balance or another method.
- Step 4: Use your preferred calculation method: For simple interest, you can rearrange the SI formula to calculate the rate. For a reducing-balance loan, use the EMI, principal and tenure to determine the rate using a loan calculator or spreadsheet.
- Step 5: Verify the result against your loan documents: Check the calculated rate against the interest rate stated in your loan agreement or Key Facts Statement. Also remember that processing fees and other charges are separate from the interest rate.
Example of Loan Interest Calculation
The table below gives an estimate of the total interest payable for different loan amounts and repayment tenures, assuming an interest rate of 12.99% p.a. and a reducing-balance method:
| Loan Amount | 3 Years | 5 Years | 6 Years |
|---|
| ₹1 lakh | ₹21,280.89 | ₹36,487.73 | ₹44,495.56 |
| ₹2 lakh | ₹42,561.78 | ₹72,975.45 | ₹88,991.12 |
| ₹3 lakh | ₹63,842.66 | ₹109,463.18 | ₹133,486.68 |
| ₹5 lakh | ₹106,404.44 | ₹182,438.63 | ₹222,477.80 |
Note: The figures above show the total interest payable over the full loan tenure, calculated using the reducing-balance method at 12.99% p.a. Actual EMI amounts vary depending on the lender's calculation method, repayment frequency and rounding.
Factors That Affect the Interest You Pay
A lot of factors decide the total interest you pay on a loan. These factors include:
- Loan amount: Borrowing a larger amount means paying more interest, especially if the loan is repaid over a longer period.
- Interest rate: A higher interest rate increases both your EMI and the total interest which will be payable.
- Loan tenure: A longer tenure can reduce your monthly EMI, but in return you will also have to pay more interest over the entire loan period.
- Credit score and repayment history: A strong credit profile and consistent repayment history can improve your chances of getting favourable loan terms, depending on the lender's eligibility criteria.
- Lender and loan type: Interest rates and calculation methods vary between lenders and different types of loans and affect the total cost of your loan differently.
- Prepayments: Making part-prepayments can reduce your outstanding principal and, in turn, the interest you pay over the remaining tenure.
Common Mistakes When Calculating Loan Interest
Calculating loan interest can be confusing if you use the wrong figures or calculation method. A lot of people make these common mistakes while calculating their loan interest:
- Using the wrong interest calculation method. Check whether your lender uses simple interest, compound interest or a reducing-balance method before calculating the interest
- Confusing interest rate with APR. While APR can include other charges, the interest rate is the cost of borrowing. Do not use them interchangeably when comparing loan costs
- Using the annual rate as the monthly rate. For EMI calculations, the annual interest rate needs to be converted to a monthly rate before applying the formula
- Ignoring the loan tenure. A longer repayment period can increase the total interest paid, even if the EMI is lower
- Calculating interest on the original loan amount throughout. For reducing-balance loans, interest is calculated on the outstanding principal, which changes as you repay the loan
- Not accounting for charges like processing fees, prepayment charges and more, which increase the total cost of the loan even if they are not included in the interest calculation.
Interest Rate vs APR: What's the Difference?
Though often confused together, interest rate and Annual Percentage Rate are not the same. While the interest rate is the percentage charged on the loan amount, the APR gives a broader view of the loan’s yearly cost by also considering other fees and charges.
| Basis | Interest Rate | APR |
|---|
| Meaning | The percentage charged by the lender on the amount you borrow | The total annual cost of borrowing |
| What it includes? | Interest charged on the loan | Interest plus fees and charges associated with the loan |
| Impact on cost | A higher interest rate means higher interest payments | Higher APR indicates a higher loan cost |
| Calculation basis | On the loan amount and applicable interest rate | On the interest rate along with fees and charges. |
How to Reduce the Interest You Pay on a Loan
Depending on your loan, you can reduce the interest you pay on a loan by making extra principal payments, switching to a lower interest rate, or shortening your repayment tenure through the following ways:
- Make part-payments towards the principal.
- Pay an extra EMI whenever possible.
- Increase your EMI as your income increases.
- Consider a balance transfer at a lower interest rate.
Why Choose NoBroker InstaCash for Personal Loan Interest Rates?
Once you’ve worked out the interest and total repayment you’re comfortable with, you can consider NoBroker InstaCash for a fully digital personal loan. You can check your eligibility, review available options and complete the application online without visiting a branch. Here’s why you should choose NoBroker InstaCash:
- Loan amount of up to ₹10 lakh.
- Interest rates starting from 12.99% p.a.
- Fully digital loan application process.
- Flexible repayment tenures of up to 60 months.
Disclaimer: NoBroker only facilitates InstaCash loans, while the loan is provided by its lending partners. NoBroker does not directly provide the loan. Read our Privacy Policy for more information.
Frequently Asked Questions
Q. Does a longer loan tenure mean more interest? Ans: Yes, a longer loan tenure can mean more interest. This is because while a longer tenure lowers your EMI, it increases the total interest paid because you repay the loan over a longer period.
Q. How does the interest rate affect my EMI? Ans: A higher interest rate results in a higher EMI and increases the total interest payable, assuming the loan amount and tenure remain the same.
Q. Is reducing-balance interest better than simple interest? Ans: They work differently. Under the reducing-balance method, interest is calculated on the outstanding principal, while simple interest is calculated on the original principal. The cost depends on the rate, tenure and other loan terms.
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Krishnan grew up in the libraries of Thiruvananthapuram. As an engineer turned writer, Krishnan is fascinated by the stories told by cities through their buildings, culture and music. His blogs are aimed at breaking down the most relevant and actionable insights on the Indian realty sector.
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