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How to Use a Personal Loan Calculator

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Starting a new loan is a very big decision. Comparing interest rates and deciding if monthly payments are affordable can make your head spin, but there are valuable resources that can help. A personal loan calculator is a (usually) free tool that allows a customer to compare details of different loans.

You don't have to speak to a loan officer or to any specific company to use a loan calculator. Best of all, there's no credit check involved, and you don't have to sign up for anyone's email list. In fact, these tools are perfect for comparing the basic facts of prospective loans to determine which one is a good fit.

What Is a Personal Loan Calculator?

A personal loan calculator is an online tool that gives consumers better insight before they decide on the right loan option. These calculators perform specific equations to calculate the interest of a loan, determine monthly payments, and estimate how long it will take to pay off a loan. Although they're similar to mortgage loan calculators, personal loan calculators focus on details more relevant to personal loans.

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While some calculators are more sophisticated than others, all personal loan calculators help a person figure out what the monthly payment of a loan will be. Since these calculators bring interest into the equation, they are also helpful in understanding the complete cost of a loan, which is always higher than the principal amount.

How to Use a Personal Loan Calculator

While different loan calculators have different features, most of them have the same basic calculations available. A user can enter the principal amount, interest rate, and term of the loan. (The principal amount is the amount of money being borrowed. The interest rate is the percentage at which interest will be paid on the loan, and the term is the length of time it will take to pay off the loan.)

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To ensure that the interest rate is accurate, it is important to make sure that the calculator accounts for the right type of interest. Some personal loans use simple interest, and others use compound interest. A simple interest rate means that you are charged interest only on the principal amount. Compound interest is more similar to the way interest accrues on a credit card — that is, any unpaid amount is added to the principal balance, and the next month's interest is calculated on that combined amount.

While the information in a personal loan calculator is often relatively accurate, it's important to realize that actual monthly payments may be a little higher than what the calculator comes up with. Some companies have other fees, such as loan origination fees, that will be factored into the price of the loan. Your loan officer or customer service representative can tell you if any fees will be applied to the loan you are interested in. Regardless of fees, a personal loan calculator is a great starting point for a consumer to take control of deciding which loan is right for you.

Benefits of Using a Loan Calculator

Numbers don't lie. Some of the more complex calculators offer greater calculations and allow you to toggle the term and payment amount. These features are great for someone who is not quite sure what terms they want, or for someone looking to forecast a variety of options.

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Sometimes, borrowers make the mistake of believing that a loan only costs as much as the amount they borrow. In reality, interest is an additional cost that must be considered. Compared to other common loans, personal loans have high interest rates. Even if the loan term only has a few years, interest rates can leave you paying significantly more than the amount you have borrowed. With any loan, a portion of your monthly payment always goes towards interest, and a portion of it goes towards reducing the principal amount.

According to Bankrate, two of the top three reasons for getting personal loans are to consolidate debt and to finance home improvements. Debt consolidation usually means paying off credit card debt. People often believe that getting a personal loan, with a 5% or 6% rate, is better than slowly paying off a huge credit card debt with an interest rate of 25% or 26%. Debt consolidation is also an attractive option because paying the minimum balance on multiple credit cards each month can become burdensome.

A personal loan calculator allows a person to compare the costs of paying off the credit card with the cost of consolidating debt with a personal loan. Since credit cards have indefinite terms and personal loans have set terms, it's important to crunch the numbers to see which option is truly cheaper. Sometimes, the interest associated with a personal loan makes it far more expensive than paying off credit cards.

On the other hand, a person who is considering a personal loan to pay for a home improvement project may be willing to pay a higher interest rate because of the value the renovations will add to their home. It may not be feasible to finance long-term home improvement projects on a credit card, but paying off a personal loan, even if the interest adds a few hundred (or thousand) dollars to the final price, may be a more workable option for some.

How Personal Loan Calculators Protect Borrowers

Of course, everyone's financial situation is different — and that's why personal loan calculators are so important. Borrowers have less legal protection in the personal loan process than they do with other types of loans, like mortgages. People often get personal loans when they are in a tough spot financially, and there are, unfortunately, predatory lenders who take advantage of this fact. Each state has usury laws to protect consumers from predatory lenders, but lenders often legally originate loans in states that have the most lenient usury laws. In other words, they find a loophole to charge the highest interest rates possible.

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A borrower who has a thorough understanding of the true cost of a personal loan can protect themselves from paying exorbitant interest over the life of the loan. Calculators give borrowers the tools they need to make the best decision for their circumstances.

Some of the most highly recommended online personal loan calculators, include:

BankRate
NerdWallet
Smart Asset
Discover

Remember: Taking out a personal loan, for whatever reason, is a big decision. Be sure to use a quality personal loan calculator to give you an edge when it comes to managing your finances.