Whether you’re taking up a business loan, car loan, or property loan, understanding how your monthly loan instalment and interest are calculated can help you make smarter financial decisions. Here’s a simple breakdown in just 3 steps:
Step 1: Work Out Your Monthly Loan Instalment Using a Formula
The first step is to determine your monthly instalment amount, which stays the same throughout the loan tenure (if it’s a fixed-rate loan).
Monthly Instalment (PMT) =
Where:
- P = Principal loan amount
- r = Monthly interest rate (annual interest ÷ 12)
- n = Total number of payments (loan tenure in months)
Example:
- Loan Amount = $100,000
- Interest Rate = 5% per annum
- Loan Tenure = 5 years (60 months)
Monthly interest rate = 0.05 ÷ 12 = 0.004166 Monthly instalment ≈ $1,887.12
This formula gives you a consistent payment amount, which includes both principal and interest components.
Step 2: Calculate How Much Interest You Pay Each Month
Each monthly loan instalment is made up of two parts:
- Interest on the outstanding loan
- Repayment of the principal
At the start of the loan, the interest portion is higher, and the principal portion is smaller. Over time, this reverses.
Formula: Interest = Outstanding principal × Monthly interest rate
Example:
Month 1 interest = $100,000 × 0.004166 = $416.67
So out of your $1,887.12 instalment, $416.67 goes to interest, and $1,470.46 goes toward reducing the principal.
| Period | Opening | Payment | Interest | Principal | Closing |
|---|---|---|---|---|---|
| 1st Month | 100,000.00 | 1,887.12 | 416.67 | 1,470.46 | 98,529.54 |
Step 3: Amortize Until the Last Instalment
Amortization is the process of reducing the loan balance over time through fixed monthly instalments.
Each month, as the outstanding principal reduces, the interest charged becomes smaller. That means a larger portion of your instalment goes toward repaying the principal.
Using the earlier example:
Month 2 opening principal = $100,000 − $1,470.46 = $98,529.54
Month 2 interest = $98,529.54 × 0.004166 = $410.54
Month 2 closing principal = $98,529.54 − ($1,887.12 − $410.54) = $97,052.96
You can track this through an amortization schedule, which shows for each month: the interest paid, principal repaid, and remaining balance.
| Period | Opening | Payment | Interest | Principal | Closing |
|---|---|---|---|---|---|
| 1st Month | 100,000.00 | 1,887.12 | 416.67 | 1,470.46 | 98,529.54 |
| 2nd Month | 98,529.54 | 1,887.12 | 410.54 | 1,476.58 | 97,052.96 |
| 3rd Month | ” “ | ” “ | ” “ | ” “ | ” “ |
By the final month:
- The interest portion is nearly zero
- The instalment is almost entirely principal
- The loan is fully paid off
| Period | Opening | Payment | Interest | Principal | Closing |
|---|---|---|---|---|---|
| 59th Month | 3,750.79 | 1,887.12 | 15.63 | 1,871.50 | 1,879.29 |
| 60th Month | 1,879.29 | 1,887.12 | 7.83 | 1,879.29 | 0.00 |
Final Thoughts
Understanding how your loan instalment and interest work helps you make better financial decisions. It gives you the confidence to negotiate with banks and pick financing options that are sustainable for your business.
At CapitalGuru, we help SMEs and business owners decode loan structures and find financing solutions that align with their goals.
Need help structuring your next loan? Reach out to us for a consultation. We’re here to help.