How do I work out the cost per month of a loan?

2 min read

Interest = the costNot the whole payment

Capital isn't a costReturning what you owe

Falls over timeInterest portion shrinks

See it on the schedulePer-payment split

Payment is not the same as cost

It is natural to think the monthly payment is what the loan costs you each month, but that overstates it. Each payment splits into interest and capital. Only the interest is the cost of borrowing; the capital portion simply returns money you owed, moving it from the lender's books back to nowhere — it is not an expense. So the real monthly cost of the loan is the interest part alone. See how the payment is built.

Reading the interest portion

Your amortisation schedule shows the split for every payment. Early on, the interest portion is large (the balance is high), so the loan is costing you more per month; later, as the balance falls, the interest portion shrinks and the monthly cost drops, even though the payment stays level. This is why the 'cost per month' of a loan is not a single number but a declining one. See why the balance moves slowly early.

Why the distinction matters

Separating cost from payment matters for two reasons. For your accounts and tax, only the interest is an expense — see what's deductible. And for judging value, comparing the real monthly cost (interest) against the benefit the loan funds is more honest than comparing the whole payment, which includes capital you were always going to repay.

See the per-payment interest on the repayment schedule, and to price a loan, apply.

Frequently asked questions

Is my whole monthly payment the cost of the loan?

No — only the interest portion is the cost of borrowing. The rest of each payment repays capital, returning money you owed rather than incurring an expense. So the payment overstates what the loan actually costs you each month. To see the true monthly cost, look at the interest portion on your amortisation schedule, which is also the part that's tax-deductible for a trading company.

Why does the interest portion of my payment fall over time?

Because interest is charged on the outstanding balance, which falls as you repay. Early in the term the balance is high, so the interest portion of each level payment is large; as the balance drops, the interest shrinks and more of each payment goes to capital. The payment stays the same, but the real cost — the interest — declines month by month toward the end of the term.