How is interest calculated on a loan?

May 14, 2019

Interest paid on a $50,000 loan will be 8 percent for the term of the loan. Does this mean the lender will earn $4,000 of interest, or will it be calculated based on what is still owed after each payment?

There are typically two types of loans – those that have a fixed monthly payment (like a mortgage), where the split between the interest and principal changes as the loan is paid down, and those that have a fixed principal payment plus interest on the outstanding balance. In each case, the interest would normally be calculated by taking the outstanding principal and multiplying it by the annual interest rate divided by 12.

For more resources, check out PICPA’s Money & Life Tips, Ask a CPA, or CPA Locator.

Answered by: David A. Caplan, CPA, is a sole practitioner in Lafayette Hill, Pa.

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