How Personal Loan Interest Rate is Calculated?

On availing of a personal loan, you are expected to repay the principal amount along with a certain percentage as interest levied by the loan provider. The payment of this amount is spread throughout the tenure of your loan.

The total interest payable throughout the tenure is an important factor to be taken into consideration because it can significantly increase the total sum payable to the lender.

What are the Factors Used to Calculate Rate of Interest?

While the Central Bank regulates the rate of interest, the rate of interest charged by different loan providers is calculated taking into account different factors like:

• CIBIL Score

This score is a reflection of your creditworthiness. The minimum CIBIL score for availing a personal loan varies according to the internal policies of the lender.

• Principal Amount

Your chances of obtaining a larger amount are higher for lenders with a good repayment history.

• Repayment and loan tenure

The shorter the repayment tenure, the lesser the total interest to be paid.

How is Interest Calculated on Personal Loans?

The interest on your personal loan or any other loan is calculated in the following manner:
EMI = [P x (R/100) x {1+(R/100)} ^N]/[{1+(R/100)}^(N-1)]

Where,

EMI = equated monthly instalments
P = the principal amount borrowed
R = loan interest rate (monthly basis) = annual interest rate/12
N = loan tenure (in months)

Let us assume that a borrower borrows a sum of Rs. 5 lakhs at a rate of 12% for a tenure of 5 years, the interest for the 1st month will be calculated as follows:

(5, 00,000*0.12/12)=5,000

The total EMI payable is the sum of the interest and principal amount.

How to Calculate Interest Component on Personal Loan EMI?

If you would like to know the interest component of your EMI for a particular month/installment, you can use the IPMT formula in Microsoft Excel. The formula is as follows

=IPMT(rate, per, nper, pv, [fv],[type])

Where

rate = the rate of interest. Thus, if you are being charged 12% annually, you need to enter 12%/12 for this field if you are calculating on a monthly basis.
per = the instalment or month for which you are calculating the interest component
nper = the overall loan tenure (in terms of number of EMIs)
pv = principal / loan amount
[fv] = this is an optional field and refers to the desired cash balance at the end of the loan tenure. Typically, this is set to 0
[type] = this can be 0 or 1 depending on whether the payment is being made at the beginning or end of the month

Here’s a working example for your reference

For subsequent months, the interest will be calculated on the new loan balance (also known as principal amount outstanding). The new loan balance is calculated as follows:

Loan paid - Principal already paid

The total interest payable is the sum of interest paid over the tenure of the loan.

It is advisable to have a clear idea about the terms and conditions and the interest payable to be able to shortlist a provider best suited to your needs. Log into the website of a loan provider, enter the details required in the personal loan calculator to help you calculate the interest and monthly installments. Make sure to invest adequate time on researching offers provided by different providers since a loan, like any other financial decision, causes a deep impact on your financial health.

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