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This article was co-written by Alex Kwan. Alex Kwan is a Certified Public Accountant (CPA) and CEO of Flex Tax and Consulting Group in the San Francisco Bay Area. He is also the vice president of one of the top five private companies. With more than ten years of experience as a certified public accountant, he specializes in providing client-focused accounting and consulting services, research & development tax services, and small businesses.
This article has been viewed 29,514 times.
When you borrow money, you will usually have to pay interest to the lender. Interest can be calculated using the simple interest method, which means you multiply the loan amount by the interest rate and loan period. The formula for calculating simple interest is I=Prt.{displaystyle I=Prt.} However, banks often charge compound interest on loans. To calculate compound interest, you add the interest to the loan’s annual principal. In the following year, interest will be calculated on the total principal plus interest. Compounding annually is the most common, but it can also be compounded monthly, even weekly, or daily. You can also earn interest (simple or compound interest) on the investments you have put your money in. [1] X Research Source
Steps
Use the simple interest formula
- For example, let’s say you buy a car that costs $12,000. You paid a $3,000 down payment and borrowed the rest. The principal of your car loan will be $9,000.
- For example, if your car loan has an annual interest rate of 7%, you would write this value in the simple interest formula as 0.07.
Tip: Some calculators automatically convert percentages to decimals. You just need to remember to press the percentage button after pressing the number.
- For example, if your car loan has a term of 60 months, you would divide 60 by 12 (the number of months in a year) to get a loan term of 5 years.
- Recipe I=Pin{displaystyle I=Pin} Can also be used when you have a loan term in months or weeks. This formula has a slight difference in that the “i” represents the interest rate for each period, and the “n” indicates the period. You would divide the annual interest rate by the number of periods in a year to get the correct value for “i,” then use the total number of months for “n.” Whether adjusting for time periods or interest rates, you will get the same results.
- P=9,000 won{displaystyle P=9,000}
- r=0,07{displaystyle r=0.07}
- t=5{displaystyle t=5}
- Interest owed is $3,150. 3,150=9000x0,07x5{displaystyle 3,150=9000×0.07×5} .
- Continuing the example above, the total amount you owe is $12,150. 3,150+9,000 won=12.150{displaystyle 3.150+9,000=12,150} .
- You can combine both equations if you want to find the total sum over the life of the loan or investment using the formula A=P(first+rt){displaystyle A=P(1+rt)} .
Compounding
- For example, let’s say you buy a house for $150,000. You paid $50,000 upfront and mortgaged the rest. Thus, the principal of your mortgage is $100,000.
- For example, if the annual interest rate on a mortgage is 8%, you would write 0.08 in the compound interest formula.
- For example, with a 10-year mortgage, you would replace “t” with 10 in the compound interest formula.
- For example, if your mortgage compounding interest is calculated on a monthly basis, it will compound 12 times a year. In the compound interest formula, this value is represented by the letter “n.” [10] X Research Source
- In the case of an investment, the interest will be compounded until the end of the deposit term or until you withdraw the invested capital.
- P=100,000 won{displaystyle P=100.000}
- r=0,08{displaystyle r=0.08}
- n=twelfth{displaystyle n=12}
- t=ten{displaystyle t=10}
- The total amount payable on the mortgage loan will be $221,964. 221.964 = 100,000 (1 + 0.08/12) 12(10) . In which, the total profit is $121,964.
- Compound interest can be significantly larger than simple interest, especially in the long run. That same loan, if calculated on the simple interest basis, would only pay $80,000 in interest over the life of the loan.
Tip: To find the total interest payable, simply subtract the principal amount from the gross amount. The result will be the total amount of interest payable over the life of the loan or investment.
Advice
- Rearrange the formula if you need to calculate principal ( P=I/CHEAPBILLION{displaystyle P=I/RT} ), interest rate ( CHEAP=I/PBILLION{displaystyle R=I/PT} ) or loan term ( BILLION=I/PCHEAP{displaystyle T=I/PR} ).
- Don’t confuse interest rate with annual percentage rate (APR). The APR includes fees that are added to interest. When comparing loans, the APR can give you a better idea of how much it will cost to take out a loan. [12] X Research Source
This article was co-written by Alex Kwan. Alex Kwan is a Certified Public Accountant (CPA) and CEO of Flex Tax and Consulting Group in the San Francisco Bay Area. He is also the vice president of one of the top five private companies. With more than ten years of experience as a certified public accountant, he specializes in providing client-focused accounting and consulting services, research & development tax services, and small businesses.
This article has been viewed 29,514 times.
When you borrow money, you will usually have to pay interest to the lender. Interest can be calculated using the simple interest method, which means you multiply the loan amount by the interest rate and loan period. The formula for calculating simple interest is I=Prt.{displaystyle I=Prt.} However, banks often charge compound interest on loans. To calculate compound interest, you add the interest to the loan’s annual principal. In the following year, interest will be calculated on the total principal plus interest. Compounding annually is the most common, but it can also be compounded monthly, even weekly, or daily. You can also earn interest (simple or compound interest) on the investments you have put your money in. [1] X Research Source
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