Find out how you calculate the interest rate on your loans

In this article

• Calculate interest rate on a loan: simple vs amortising loan

• How is interest calculated on a loan?

• What factors impact interest on a loan?

• How to get the best loan interest rates?

• How is interest calculated on a credit card?

• What factors impact credit card interest?

• Conclusion

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Whenever you borrow a loan, the lender charges interest on the loan, which represents the cost of borrowing the loan.

Knowing how loan interest is calculated can help you better understand your repayment obligations. When you repay the loan, you not only pay off the principal but also repay the interest.

Here's what you should learn about how to calculate the interest rate on loans:

Calculate interest rate on a loan: simple vs amortising loan

A common question that plagues borrowers is how to work out interest on a loan. Usually, the interest on any type of loan is determined based on the daily unpaid balance of the amount borrowed.

Remember that the approach adopted by lenders for calculating interest on loans varies. Some opt for the simple interest method, while others use an amortisation schedule. Lenders may also follow a different approach to calculate the interest for high-risk loans such as payday loans. Similarly, in the case of consistent loan default on an existing borrowing, lenders may revisit the interest rate.

Here's how interest rate is calculated for simple and amortising loans:

Simple loan

If you want to calculate interest payment using the simple interest method, you need to know the principal amount borrowed, the interest rate charged, and the number of months or years you have to repay the loan.

Use the following formula to calculate interest on a loan: Principal loan amount x interest rate x loan term = interest

For instance, if you borrow $5,000 for five years and the interest rate is 5 percent, as per the simple interest formula, you need to pay $1250 as interest.

However, calculating interest on a loan using the simple interest method is only restricted to short-term borrowings.

Amortised loan

The interest for bigger loans, such as a refinance mortgage, is worked out based on an amortisation schedule.

The monthly instalment is fixed at the time of disbursal, and the loan is repaid in equal instalments.

The initial instalments are used towards paying off the interest. As you get closer to repaying the final payoff date, the instalments are applied towards paying off the principal and other fees and costs.

Here's how to calculate interest on a loan that is amortised:

• The applicable interest rate of the loan should be divided by the number of payments you need to make in a year. For instance, if the loan carries 6 percent interest and you need to pay an instalment every month, you must divide 0.06 by 12.

• The result (which is 0.005 in this case) should be multiplied by the loan balance. This will tell you how much interest you need to pay during a particular month. Suppose you have a mortgage, and the outstanding is $6,000 -- so how to calculate mortgage interest for the first month. In this case, it is $6,000 x 0.005, which is $30.

• The next step of interest on loan calculation involves subtracting the interest from the monthly instalment amount. This tells you how much you need to pay towards the principal. For example, if the monthly instalment has been fixed at $400, you will pay $370 towards the principal, which gets deducted from the outstanding amount.

• For each subsequent month, you need to change the new loan balance for the preceding month in the monthly repayment formula to work out the amortised interest.

As the above example shows, calculating the amortisation schedule requires a lot of maths. Wondering how to calculate principal and interest payments for an amortised loan easily? You can use an online calculator that does the job for you. All you need to do is feed in the data.

Calculation of interest on an amortised loan can also be done through Microsoft Excel or Google Sheets, as they have in-built calculators.

How is interest calculated on a loan?

To calculate interest on a loan, multiply the loan balance by the interest rate specified by the lender. When you divide the result by the number of days of the year, you get the daily interest.

For example, if you have borrowed $200,000 at 2.52 percent per annum. The daily interest will be $ 200,000 x 0.0252/365, which is $13.81

And how to calculate monthly interest on a loan? Multiply the daily interest by the number of days of the month.

Therefore, for January, it will be $13.81 x 31, which is $428.11.

How much would a loan cost per month? Quick examples

Understanding formulas is one thing, but seeing real numbers makes it easier to plan your budget. The table below shows estimated monthly repayments and total interest for common personal loan amounts in Australia, assuming a fixed-rate, fully amortised loan with no upfront or ongoing fees.

So, how much would a $30,000 personal loan cost per month? At 7% over five years, you would pay roughly $594 each month and around $5,640 in total interest over the life of the loan. Shorten the term to three years and the monthly repayment jumps to $926, but total interest drops to $3,336 - nearly 41% less.

These figures illustrate the trade-off between affordability and overall cost. A longer loan term lowers your monthly outgoing but increases the total interest you pay. Use the amortisation method explained above to calculate interest on a loan for your specific amount, rate and term, or plug the numbers into an online repayment calculator for an instant estimate.

What factors impact interest on a loan?

Interest rate

The interest rate plays a critical role in calculating the total cost of borrowing any loan.

The total interest paid for the loan will be higher if the interest rate is higher.

Also, consider whether the interest rate offered by the lenders is variable or fixed. The total interest cost can fluctuate through the life of your loan if the interest rate is variable.

Loan amount

The amount you borrow has a significant impact on loan interest calculations. The more you borrow, the more it costs.

For example, suppose you borrow an amortised personal loan of $10,000 for five years at an interest rate of 5 percent. In this case, you will pay $1,322.74 as interest.

However, if you borrow $15,000 for the same term and interest rate, the total interest increases to $1,984.11.

As a rule of thumb, refrain from borrowing more than you need, as it can translate into higher interest payments.

Loan term

Loan term refers to the period within which you need to repay a loan. The longer the loan term, the more interest you need to pay.

Shorter loans, such as car loans, have higher monthly instalments. But you pay lesser interest overall since the timeline is constricted. However, home loans (that are typically for 25 or 30 years) require you to pay higher interest over time since the timeframe for repayment is considerably longer.

In other words, the interest paid varies depending on how long you take to repay the loan.

Fixed vs variable interest rates: how they change your total cost

When learning how to calculate interest rate on a loan, it is important to understand whether the rate is fixed or variable, because the method - and the total cost - can differ significantly.

How fixed-rate interest is calculated over the loan term

A fixed interest rate stays the same for the entire agreed period (or a set portion of it). Your monthly repayment is locked in from day one, making it straightforward to calculate interest on a loan: you apply the same rate to the declining balance each month using the amortisation method. There are no surprises, and you know exactly how much total interest you will pay before you sign the contract.

How variable-rate interest is recalculated when the rate moves

A variable (or floating) rate is set by your lender and can change over time - typically in response to the Reserve Bank of Australia's cash rate. When that benchmark moves, your lender may adjust your loan rate accordingly. Each time the rate changes, the interest portion of your next repayment is recalculated against the current outstanding balance at the new rate. This means your monthly repayment amount can rise or fall over the life of the loan, and the total interest paid is impossible to predict with certainty at the outset.

Worked example: same $20,000 loan under fixed 6% vs variable starting at 5.5%

Consider a $20,000 personal loan over five years. With a fixed rate of 6%, your monthly repayment is approximately $387, and total interest comes to around $3,220. Now suppose you take the same loan at a variable rate starting at 5.5%. In the first year your repayment is roughly $382 - slightly cheaper. However, if the rate rises to 6.5% in year two and 7% in year three, your monthly repayment climbs to around $400 and total interest over five years could reach $3,600 or more. Conversely, if rates fall, you could pay less overall than the fixed option.

Which type suits short-term vs long-term borrowers in Australia?

Fixed rates suit borrowers who value certainty, particularly for longer-term loans such as home loans where even a small rate increase compounds over decades. Variable rates can benefit shorter-term borrowers who are comfortable absorbing modest rate rises and want the flexibility of extra repayments or early payoff without break fees. In Australia, many lenders allow you to split a loan into fixed and variable portions - a strategy worth exploring if you want a balance of predictability and flexibility.

How to get the best loan interest rates?

Here's what you can do to maximise your chances of borrowing a loan at an attractive interest rate:

Work on your credit score

Your credit score indicates your creditworthiness.

Borrowers in the top Soaring high band have a better chance of being offered the most competitive interest rates for loans. On the contrary, a low score in the Raise your game band can push you to borrow specialised loans such as home loans for bad credit that carry a very high-interest rate compared to standard mortgage loans.

To improve your credit score, pay your loan instalments on time and avoid unnecessarily applying for additional credit.

If you don't know your current score, you can check credit score for free with ClearScore, anytime.

Opt for a shorter repayment timeline

Opting for a shorter-term loan may help you access a more competitive interest rate, though approval and pricing always depend on the lender's own checks.

However, you should exercise the option only if you can afford the repayments. Missing instalments can negatively impact your credit score, forcing you to reach out to specialised lenders for future borrowings.

However, products such as a personal loan for bad credit carry a higher interest rate as your creditworthiness declines because of a lower credit score.

Pay attention to your debt-to-income ratio

When lenders evaluate your loan application, your debt-to-income (DTI) ratio is critical in determining the interest rate offered.

DTI is the ratio of the debt you have to your gross monthly income. The lower your DTI, the better your chances of getting a low-interest loan.

Comparison rate vs advertised rate: what Australian borrowers need to know

What is a comparison rate and why does Australian law require it?

Under the National Consumer Credit Protection Act, Australian lenders must display a comparison rate alongside the advertised (or headline) interest rate for most consumer loans. The comparison rate is designed to give borrowers a more realistic picture of a loan's true cost by folding in certain fees and charges that the headline rate alone does not capture. Its purpose is to make it simpler to compare products from different lenders on a like-for-like basis.

How the comparison rate is calculated

The comparison rate is calculated as a single percentage that combines the interest rate with most standard upfront and ongoing fees - such as establishment fees, monthly account-keeping fees, and discharge fees - over a prescribed reference loan amount and term. The regulations set six designated pairs - from $250 over two weeks up to $150,000 over 25 years - and the lender must use whichever pair most closely matches the typical amount and term for the product being advertised, so a personal loan is quoted against a much smaller reference loan than a home loan. Because the reference amount and term vary by product, a comparison rate is most useful for comparing loans of a similar size and term, and different amounts or terms will produce a different comparison rate. However, it does not include every possible charge (for example, redraw fees or early-exit fees), so it is still worth reading the fine print.

Why the advertised rate can be misleading

A lender might promote an advertised rate of 5.99% per annum, which looks competitive at first glance. Once monthly fees of $10 and an establishment fee of $250 are included, the comparison rate is higher than the advertised rate. On a $20,000 loan over five years, that gap can translate into hundreds of dollars of additional cost. Focusing only on the headline rate when you calculate interest on a loan risks underestimating what you will actually pay.

How to use the comparison rate when shopping for loans

Start by shortlisting loans with the lowest comparison rates rather than the lowest advertised rates. Keep in mind that the comparison rate is calculated on a prescribed reference amount and term for that type of product, so it may not perfectly reflect costs for much smaller or larger amounts, or for a different term. For the most accurate picture, ask each lender for a personalised quote that itemises every fee, then use the amortisation method outlined earlier in this article to calculate the total repayment for your specific loan size and term.

How is interest calculated on a credit card?

Even though credit cards are a type of financial assistance, interest rate calculation for credit cards is not the same as for loans.

The interest rate for a credit card is calculated daily based on the outstanding balance. It includes purchases that don't enjoy any interest-free period, balance transfers, cash withdrawals from ATMs, interest carried over from previous months, and other fees levied by the issuer.

Typically, lenders charge different interest rates for purchases, balance transfers, and cash withdrawals.

What factors impact credit card interest?

The amount of credit card interest paid every month depends on several factors, such as:

How much you repay

If you only pay the minimum amount due on your card instead of paying the dues in full, you do not enjoy the interest-free period of your card. In such cases, the total interest paid quickly adds up over time.

Type of credit card you hold

The interest rate of credit cards that permit their holders to earn reward points is higher. Cards that do not offer such perks charge lower interest.

The number of days in the month

Since the interest is calculated on a daily basis, more days in a month means higher interest paid.

The best way to reduce credit card interest paid is by paying the outstanding dues in full by the due date. If you find managing interest payments on your credit cards difficult, consider opting for a low-interest-rate card. Alternatively, you can borrow debt consolidation loans to clear your dues, but only take on credit you can afford to manage and repay.

Conclusion

'How much interest will I pay on my loan' is a crucial consideration for any borrower. It can be easier to decide once you know how to calculate interest rate per month for the loan you plan to borrow.

Frequently asked questions about loan interest

How does bad credit affect the interest rate on a loan?

Lenders use your credit score to gauge repayment risk. A lower score signals higher risk, so the lender compensates by charging a higher interest rate - sometimes several percentage points above what a borrower with excellent credit would pay. In some cases, mainstream lenders may decline the application altogether, leaving specialist products such as personal loans for bad credit as the primary option. These loans typically carry elevated rates and stricter terms. If you are unsure where you stand, you can check credit score for free with ClearScore to see what lenders are likely to see before you apply.

Is the interest rate on a secured loan lower than an unsecured loan?

Generally, yes. A secured loan is backed by an asset - such as a car or property - that the lender can claim if you default. This collateral reduces the lender's risk, which typically translates into a lower interest rate compared with an unsecured loan of the same amount and term. For example, a secured car loan in Australia might carry a rate two to three percentage points below an equivalent unsecured personal loan. The trade-off is that you risk losing the asset if you cannot keep up with repayments.

What affects whether a loan application is approved in Australia?

Approval criteria, affordability requirements and pricing vary by lender and by application. Some small unsecured personal loans and payday loans have broader criteria because the amounts are lower, but these usually carry higher interest rates and fees. Payday loans, for instance, may seem convenient but can be very expensive over a short term. Before choosing the easiest option, compare the total cost of borrowing - including fees and interest - across several products to make sure you are not paying significantly more than necessary.

Can I reduce the interest I pay by making extra repayments?

Yes, in most cases. When you make an extra repayment, the additional amount goes directly towards reducing the principal balance. Because interest is calculated on the outstanding balance, a lower principal means less interest accrues each day. Over the life of the loan this can save you a considerable sum and shorten your repayment period. Before making extra payments, check your loan contract for any early-repayment or break fees - particularly on fixed-rate loans - as these charges can offset some of the interest savings.