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Monthly Interest Formula:
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Monthly interest payment represents the amount of interest charged on an outstanding loan balance for one month. This calculation is fundamental in amortized loans where payments are applied first to interest and then to principal reduction.
The calculator uses the monthly interest formula:
Where:
Explanation: The formula converts the annual interest rate to a monthly rate by dividing by 12, then multiplies by the outstanding balance to determine the monthly interest charge.
Details: Understanding monthly interest payments is crucial for budgeting, loan comparison, and financial planning. It helps borrowers understand how much of their payment goes toward interest versus principal reduction.
Tips: Enter the outstanding balance in currency units and the annual interest rate as a decimal (e.g., 0.075 for 7.5%). Ensure both values are positive and the rate is between 0 and 1.
Q1: Why divide the annual rate by 12?
A: This converts the annual percentage rate to a monthly rate since there are 12 months in a year, allowing for accurate monthly interest calculations.
Q2: Does this calculation include principal payments?
A: No, this calculates only the interest portion. Total monthly payments on amortized loans include both interest and principal components.
Q3: How does the interest change over time?
A: As the outstanding balance decreases with each principal payment, the monthly interest amount also decreases over the loan term.
Q4: What's the difference between simple and compound interest?
A: This calculator uses simple monthly interest. Compound interest would involve interest earning additional interest, which is more common in savings than loans.
Q5: Can this be used for credit card interest?
A: Yes, but credit cards often use daily compounding, so this provides an approximate monthly interest calculation.