This payment calculator figures both types of monthly loan payments – interest-only vs....show more instructions
How Two Types Of Loan Payments Work: Interest-Only Vs. Principal And Interest
It is important to understand how your loan payment terms work before taking out a loan.
Different loan payment methods will effect you budget and how much principal you owe at the end of the loan term. They also offer different risk profiles.
This Loan Payment Calculator will help you calculate two types of loans: interest-only vs. principal and interest. Compare their payments side-by-side to gain a better understanding of your loan situation so that you have the knowledge required to make an appropriate loan choice.
Let’s explore how each type of loan payment works.
Loan Payment Types
Conventional principal and interest loan payments amortize the repayment of your debt over a period of time. This simply means that you pay the same amount each month during the entire term of the loan with a varying portion of each payment dedicated to interest and principal.
Home and car loans are typically conventional, amortized loans. During the early life of the loan a bigger portion of your monthly payment is applied to the interest. As time goes on, the interest payment reduces while the principal payment increases until the loan is fully amortized (paid off).
Interest-only loan payments are typically made for a shorter period of time, at the end of which these loans are either converted to standard loans or they balloon (meaning the full principal is due at the end of the loan term).
During the interest-only period, there is no amortization of the principal giving the apparent advantage of lower payments than their conventional principal and interest loan counterparts. The downside, of course, is that you are not making any progress on repaying your debt.
Another strategy to accelerate your loan payoff is to make additional principal payments with your regular loan payment.
If you put additional money toward a loan, the payment may be applied to the principal, thus, reducing the principal amount faster than normal. This has a compounded effect because the reduced principal increases the amount of each subsequent payment dedicated to principal with less going to interest. The net result can be a dramatically accelerated debt payoff.
Another alternative for additional payments is to dedicated the money toward your next loan payment – essentially prepaying your loan instead of paying down the principal. Normally, you have the choice where your additional money goes.
Before you increase payments to your loan, you should ask your lender how extra payments will be applied. Also ask your lender if there are any penalties for making additional loan payments, since each lender has different rules for handling loans (remember, interest-only loans may require you to only pay interest for a specific period of time).
How Much Will You Pay For The Loan Each Month?
Once you know which type of loan you are taking then it will be easier to calculate your monthly loan payments.
Loan payments are usually uniform each month until the end of the loan term, except for variable-rate loans. The interest rate of a variable-rate loan is often connected to the Consumer Price Index or Libor and will rise and fall with changes in interest rates. Therefore, if the Consumer Price Index declines, the interest rate also falls which means that your loan payment will also decrease.
Calculating your monthly payment for fixed-rate loans is made easy using this Loan Payment Calculator. You can find the monthly payment by just entering the loan amount, annual interest rate, and the loan term. The calculator does the rest.
Before you take out a loan, make sure you match the terms and conditions to your personal goals. Do you need lower payments or do you prefer to amortize the loan and get out of debt? Also, make sure you can afford the loan payment.
Consider your options carefully. While interest-only loans look attractive due to their lower monthly payments, remember that those payments can suddenly skyrocket when the interest-only period expires. You will also not make any progress on getting out of debt during the interest only payment period – not a good thing.
That’s one advantage of looking at the principal and interest loan payment: it gives you a much better idea how much your loan should cost you each month.
The Loan Payment Calculator can help you compare your options – empowering you to make the best decision for you and your family. Smart choices are made by gathering facts to weigh risk and opportunity. Select a loan payment that works for you, and consider a plan to accelerate your payments as well.
Loan Payment Calculator Terms & Definitions
- Principal – The amount of money originally lent or the remaining amount of borrowed money.
- Interest – Money paid regularly at a particular rate for the use of money lent.
- Interest-Only Loan – A loan which, for a set term, the borrower pays only the interest on the principal balance, with the principal balance remaining unchanged.
- Principal and Interest Loan – Loans where payments are applied both to principal and interest, in differing amounts depending on the age of the loan.
- Annual Interest Rate – The percentage interest rate charged for borrowing money.
- Term – The time period for which the money is borrowed.
- Monthly Payment – The amount of money you pay for your loan each month.
- Loan – A sum of money that is borrowed and expected to be paid back with interest.
- Amortization – The distribution of payment into multiple cash flow installments as determined by an amortization schedule.
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