How to calculate loan payments

Borrowers feel the pinch from the moment they take out a loan. That's why it's key to figure out your loan payments before rather than after you take out a business loan.

Not sure where to start? Keep reading for a walkthrough of how to calculate loan payments for two common types of loans.

Amortizing vs. interest-only loan payments

The type of loan you plan to take out will dictate how you calculate loan payments. Generally speaking, there are two common types of loans are the amortizing and interest-only.

Let's start with the standard amortizing loan. You would pay down both the principal and interest on a gradual basis until you pay off the whole loan. You would make fixed periodic payments over the life of the loan. Lenders view these loans as low-risk because they get back a part of the principal with each loan payment. It's also easier to budget for these loans because you pay the same amount during each period.

With an interest-only loan, you pay down the interest until the loan matures. At that time, you pay off the principal as a lump sum. The delayed principal payments might seem like a benefit to cash-strapped business owners.

But lenders view these loans as riskier. This is because the borrower does not pay back the principal until late in the borrowing period.

You might also find it difficult to budget for the sudden rise in payment resulting from the lump sum. A lack of proper budgeting can lead to the inability to repay the principal.

How to calculate amortizing loan payments

Use the following formula for how to calculate loan payments on an amortizing loan.

A = P({i[1+i]^n} / {([1+i]^n)-1})

Where:

A is the periodic payment amount

P is the principal or the original loan balance, less any down-payments

i is the periodic interest rate. To calculate i, divide the nominal annual interest rate as a percentage by 100. Divide that figure by the number of payment periods in a year.

n is the total number of periods. To calculate n, multiply the loan duration in years by the number of payment periods in a year.

Let's take a look at an example of an amortizing loan repaid on a monthly schedule. Say you want to take out a 5-year, $25,000 loan at a nominal annual interest rate of 6 percent.

P is $25,000

i is .005 ({6/100} / 12 months in a year)

n is 60 months (5 years * 12 months in a year)

 Your monthly loan payment would be approximately $483.

 Here's the math:

A = 25,000({.005[1+.005]^60} / {([1+.005]^60)-1})

A = 25,000(0.00674425076 / 0.34885015254)

Loan Payments = $483.32