How Is Loan Interest Calculated?

Most auto, personal, and student loans are "amortized," which sounds complicated but isn't. Understanding how the interest is figured helps you see why extra payments save so much. Here's the plain-English version.

→ See your loan's interest broken down month by month

Interest is charged on your balance

Each month, your lender multiplies your remaining balance by your monthly interest rate (your APR divided by 12). That's the interest for the month. The rest of your payment goes to principal, reducing the balance.

Example: a $20,000 balance at 6% APR has a monthly rate of 0.5%. First month's interest = $20,000 × 0.005 = $100. If your payment is $387, then $100 is interest and $287 pays down principal.

Why early payments are mostly interest

Because interest is based on the balance, it's highest at the start when you owe the most. So early payments are weighted toward interest, and later payments toward principal. This is why a loan balance seems to drop slowly at first, then faster.

→ Watch your balance fall faster with extra payments

Why extra payments save so much

Any extra payment goes 100% to principal. That lowers the balance immediately, so next month's interest is smaller — which means more of your normal payment also goes to principal. The effect compounds, which is why even small extras can save hundreds.

Simple interest vs. amortized

Most installment loans use this monthly amortized method. A few short-term loans use simple interest on the original amount. Always check, but for auto, personal, and student loans, amortization is the norm.

How to check your own loan

Your monthly statement or amortization schedule shows the split between interest and principal for each payment. To estimate it yourself: multiply your current balance by your APR, then divide by 12 — that's roughly this month's interest. Whatever's left of your payment goes to principal. Watching that split shift over time (less interest, more principal each month) is satisfying, and it makes the impact of an extra payment obvious: every extra dollar skips straight to the principal side.

The bottom line

Loan interest each month is just your balance times your monthly rate; the rest of your payment cuts principal. Because interest follows the balance, paying extra early removes future interest — the core reason early payoff is so powerful.

→ See exactly where your payments go — free calculator