Finance⏱ 5 min read
How to Calculate the True Cost of a Personal Loan
The APR comparison rate and the actual amount you repay are very different numbers. Here is how to calculate total interest, the effective rate you are really paying, and when a personal loan beats a credit card.
A personal loan at 8.9% APR sounds straightforward. But the total interest paid, the monthly payment, and whether it beats your alternatives require actual calculation -- not just a glance at the headline rate.
Monthly Payment Formula
Monthly payment = P x (r x (1+r)^n) / ((1+r)^n - 1)
P = principal (loan amount)
r = monthly interest rate (APR / 12)
n = number of monthly payments
Example: £10,000 at 8.9% APR over 3 years (36 months):
Monthly rate r = 8.9% / 12 = 0.7417% = 0.007417
Monthly payment = 10,000 x (0.007417 x (1.007417)^36) / ((1.007417)^36 - 1)
= 10,000 x (0.007417 x 1.3095) / (1.3095 - 1)
= 10,000 x (0.009713) / (0.3095)
= 10,000 x 0.03138
= £313.80/month
Total Cost and Total Interest
Total repayment = Monthly payment x Number of months
= £313.80 x 36 = £11,296.80
Total interest paid = Total repayment - Loan amount
= £11,296.80 - £10,000 = £1,296.80
As a percentage of loan: £1,296.80 / £10,000 x 100 = 12.97%
Over 3 years, you pay 13% of the loan as interest.
At 5-year term (60 months, same 8.9% APR):
Monthly payment: £207.20
Total repayment: £207.20 x 60 = £12,432
Total interest: £2,432 (nearly double the 3-year loan)
Lesson: shorter terms pay significantly less interest,
but require higher monthly payments.
When Personal Loan Beats Credit Card
Credit card at 22.9% APR vs personal loan at 8.9% APR:
For £5,000 balance, minimum payments (2%):
Credit card: approximately 30+ years to repay, £9,000+ total interest
Personal loan (3 years): 36 payments, £645 total interest
The personal loan is approximately 14x cheaper in total interest.
Break-even: personal loan vs 0% purchase credit card:
0% for 24 months, then 22.9%
Personal loan 8.9% for 24 months
On £5,000:
0% card (repaid in 24 months): £0 interest
Loan (8.9% over 24 months): £480 interest
The 0% card wins -- IF you repay before the 0% period ends.
If you don't repay in time: the loan is dramatically better.
Early Repayment Charges
Most personal loans allow early repayment with:
Statutory limit: maximum 1-2 months interest as an early repayment charge (ERC)
(Under Consumer Credit Act, lenders cannot charge more)
On £10,000 loan at 8.9%, paying off 12 months early:
Outstanding balance at month 24: approximately £3,555
ERC (1 month interest on outstanding): £3,555 x 0.7417% = £26.36
Total saved by early repayment: approximately £95 in future interest
Net benefit: £95 - £26 = £69 saving
Early repayment is almost always worthwhile on personal loans
because the ERC cap is low compared to interest saved.