Each loan requires paying installments. It is obvious. The installments depend primarily on the amount borrowed and the length of the loan period. We also know that. But how to calculate the loan installment? Calculating the loan installment can be simple and difficult at the same time. It all depends on who. For some people, banking mathematics seems very complicated, others are able to calculate installments and loan costs, in memory. Do you have a strict mind or are you a humanist? Not relevant! Even if math has never been your horse, you’ll soon find out how easy it is! How to calculate the loan installment?
Calculating the loan installment step by step
How do you calculate the loan? To start with, we must know that each loan installment consists of two parts:
- The capital part is the borrowed amount that you pay off every month,
- The interest part is an addition to the capital installment, which depends on the interest rate on the loan.
Insurance premiums are also often added to your loan installment if you use the loan insurance option. Credit insurance protects you in the event of fortuitous events such as job loss, inability to work, serious illness or even death. In most cases, insurance is not compulsory, but all this affects the total cost of your liability.
In the case of mortgage loans, there are 2 types of installments:
1) Fixed installments – As the name implies, each paid installment will be the same. Installments remain unchanged throughout the loan period. Sometimes only the last installment will be an equalization installment, so it may differ from the others.
How to calculate the loan installment? Calculation of the fixed installment is quite difficult.
- First, we calculate the interest part, which depends on the remaining loan amount and the number of days in a given month.
- Next, we add the capital part, which is equal to what is missing to the fixed fixed installment, after taking into account the interest part.
Simply put, we have to add enough capital to the interest amount each month so that the monthly installment is always the same.
This means that the equity portion will be low at the beginning of the repayment period and will increase over time. The amount of interest at the beginning is higher because the amount to be repaid is large. With each month, when the amount decreases, interest also decreases. But the monthly installment remains the same.
2) Decreasing installments – In the case of decreasing installments, the situation is different. At the beginning of paying off the loan we pay more, but over time the amount will decrease.
- The decreasing installment has a fixed capital part, which means that we repay the same amount of capital every month and it’s easy to calculate: loan amount, divided into the number of installments.
- On the other hand, the interest part will be getting smaller each month, because interest will be charged on an ever lower amount.
Formula for calculating the decreasing loan installment:
capital part = initial loan amount / number of all installments
interest portion = outstanding loan amount * interest per annum / number of installments per year
installment = capital + interest part
Most often, the bank offers us a specific type of installments. Fixed installments, although often higher, give a sense of stability and allow us to avoid surprises if we do not attempt to calculate the loan installments ourselves.
Decreasing installments are best for people with high creditworthiness and correspondingly high earnings. At the beginning of the loan period, the amount will be quite high, but will decrease over time, which in the longer term will prove very profitable.
What should the loan installment be?
Since the calculation of the loan installment is already in your fingertips, let’s think about what the installment should be? To assess our credit standing and financial standing, we need to calculate the DTI.
The DTI is the amount of the loan installment, compared to our monthly income. Banks, when verifying our creditworthiness, also use it and, most importantly, DTI contains all our obligations that we have to pay regularly, including those due to having credit cards.
The DTI level can be determined very simply. We sum up the installments of our monthly obligations and divide them by the monthly net income that we get on hand. In this way, we obtain the percentage share of loan installments in our monthly budget.
How much should the DTI be? It is assumed that the total amount of monthly credit obligatiaons should not exceed 1/3 of our earnings, although it depends mainly on our lifestyle. If the DTI ratio for clients with average incomes exceeds 40%, banks should be given a warning light, but ultimately the acceptable indicator depends on the internal policy of each bank. However, it is worth remembering that the bank does not take into account whether we have a month or two installments left for the final repayment of the current liability. He is interested in the current situation, so before we apply for a mortgage, we should end the repayment of previous obligations, if possible.
DTI, however, is the most important for borrowers themselves. 50% of total commitments should be the absolute maximum for us. Possibly 65%, but only for people with high earnings.