Personal loan monthly payments: how they work

It's always smart to level up your financial knowledge—and it could snag you some cash, too. When it comes to personal loans, knowing how your monthly payments work could significantly boost your borrowing game, saving you money and getting you debt-free quicker.

Personal loans are installment loans where you make the same payment every month for a set period of time. Most personal loans are amortized, meaning part of each payment goes to your principal and part goes to interest and other fees. The total payment amount stays the same from month to month, but the distribution of that payment varies throughout your loan. 

When you know how your personal loan payments work, you can adjust your repayment strategy to maximize savings. To help you master your loan payments, we'll go over them in detail, from what they include to how they're calculated—and how you can save as much money on them as possible.

What personal loan monthly payments include

Most personal loans are amortized loans where you make one monthly payment that the lender breaks up into several portions:

• Principal. This is the part of your payment that goes to your principal balance. In other words, it's the part that actually pays back the money you borrowed. 

• Interest. This is the part that covers your monthly interest charge. It covers the cost of borrowing the money. The interest fee is calculated every month based on your principal amount and your interest rate. Personal loans typically have fixed interest rates.

• Other fees. A portion of your monthly payment may go toward other loan fees as agreed in your loan contract.

Because the interest is based on your principal balance each month, your total interest fee gets smaller as your principal gets paid down. So each month, the principal portion grows and the interest portion shrinks.

Example: How do loan payments work on a personal loan?

Let's look at an example of how personal loan payments work. Say you borrow $5,000 for two years at 18% interest. 

Your monthly loan payment would be about $250 every month. For the first month, the lender will split up your loan payment this way:

• $175 goes to your principal

• $75 goes toward your interest fees

The next month, the payment is split slightly differently because your principal balance is a little lower. In month two, your $250 payment is split up like this:

• $177 goes to your principal

• $73 goes toward your interest fees

By the time you're making the last payment, it would look something like this:

• $246 goes to your principal

• $4 goes toward your interest fees

How amortization works (aka why initial payments are mostly interest)

In an amortized loan, the fixed monthly payment includes both the principal and interest payments. An amortized loan has the same total monthly payment, but how that payment is distributed varies each month based on the principal balance and interest fees.

When you get a new loan, the lender should provide you with an amortization schedule that shows you exactly how each monthly payment will be split up throughout the loan.

Let's look at an amortization table based on the two-year $5,000 loan at 18%:

With shorter loans, the larger monthly payment means a good chunk of each payment still goes toward your principal. If you have a longer loan, the lower monthly payment could mean the interest portion is larger than the principal portion.

For example, let's say the $5,000 loan was for five years instead of two. The total monthly payment drops to about $127, which means the amortization table looks very different. Here's what Year One would look like:

The first monthly interest charge is the same for both loan term examples, but the total monthly payment is much lower on the longer-term loan. As a result, the portion that goes to the principal is much lower, as well.

How monthly loan payments are calculated

Lenders use a mathematical formula to calculate your fixed monthly loan payment. The factors that go into it include:

• Principal amount

• Monthly interest rate (annual rate divided by 12)

• Loan term (total number of monthly payments)

The fixed monthly loan payment is calculated when you apply for the loan. It generally won't change during the life of the loan.

The part that changes each month are the portions that go to principal and to interest. Your interest fee is calculated every month based on your principal balance. As your principal shrinks, so does the amount of interest you have to pay, so less of each payment is taken up by interest.

How do you calculate monthly payments?

Lenders use a specific formula to calculate your payments. For most borrowers, an online loan calculator is the simplest way to get an idea of what your monthly loan payment would be. These let you input different loan sizes, terms, and interest rates to get an estimate of the monthly payment for each scenario.

Why monthly payments stay the same on a fixed rate loan

Amortization can seem complicated, but it really makes things simpler for borrowers since it allows you to have the same fixed monthly payment for the entire loan. The portions that go to principal and interest change each month, but it's behind the scenes—you don't need to do any of the heavy lifting to figure it out.

Fixed monthly payments can be a boon for budgeting since they're easier to work into your monthly budget. You always know how much the payment will be that month so you don't get any surprises.

Will my loan payment ever change?

Not usually. Personal loans tend to have the same fixed monthly payment every month for the life of the loan. Changing the loan terms requires agreement from the lender and only occurs under unusual circumstances, such as asking the lender for help if you're facing financial hardship.

Factors that affect your monthly payment

At the most basic level, your monthly loan payment depends on just three factors:

• How much you borrow

• The interest rate

• The number of payments

In practice, it's a bit more complicated. That's because each of those factors could be influenced by any number of other things. Here are some examples:

• Your credit history. The interest rate for your loan will depend very heavily on your credit scores. Higher credit scores tend to get lower interest rates.

• Loan fees. Some lenders may charge fees other than interest that get added onto your balance. Those fees could impact your monthly payment amount.

• Lender policies. Some lenders offer payment or rate discounts for things like autopay or for having a pre-existing relationship.

How to reduce your total interest or get a lower monthly payment

While your monthly loan payment is generally fixed, you could still have ways to reduce your loan costs or otherwise change things up. Consider these scenarios.

Cut your total interest by making extra payments

Your monthly loan payment is the minimum you need to pay each month—but you could choose to make extra payments. Anything extra you pay toward your loan typically goes straight to your principal.

Since your interest is calculated each month based on your principal, extra payments to your principal reduce how much interest you pay going forward. Extra payments can be especially impactful at the beginning of a loan when the interest portion of your payment is largest.

Refinance your loan at a lower interest rate

The interest rate you get on a loan is determined by several factors, and your credit is the largest one. If you've improved your credit score, you could qualify for a personal loan with a lower interest rate. Refinancing your loan—paying off an existing loan with a new loan—at a lower rate could reduce your monthly payments.

Refinance your loan with a longer term

Another way to reduce your monthly payments could be to refinance with a longer repayment term. Longer loans typically have lower monthly payments, which could be better if you're having trouble meeting your obligations. However, more monthly payments means paying more interest, so the total cost of your loan will likely go up if you extend your repayment term.

Does paying extra reduce my loan cost?

Yes, making extra loan payments could reduce the total cost of your loan. Anything extra you pay on top of your monthly payment typically goes to your principal. This generally reduces how much interest you pay over the life of the loan, reducing the overall cost.

Why you should shop around when you get a new loan

Since so many factors go into your monthly loan payment, there's a lot you could do to save money on your next personal loan. Prequalify with at least a few lenders to get an idea of what your best-case terms could be. Compare the monthly payment, interest rate, and total cost of the loan when shopping around. 

Ready to get started? Check your rate with Achieve Personal Loans with no impact to your credit score.