How are Interest Rates Calculated?
Interest rates are part of borrowing money, and if you borrow money, you will be expected to pay the money back over time. You will also be expected to pay a little something for the service the lender has provided you, meaning you will not just pay the money you borrowed. You will also pay interest.
Interest is the price you pay to borrow money from someone else, and it is one of the major ways that lenders earn profit. There are many interest calculations, and one of the easiest is simple interest.
To calculate simple interest, you need the principal loan amount, the interest rate, and the number of months you will be paying the loan. The calculation for simple interest is: principal loan amount x interest rate x time (number of months or years of the loan) = interest.
For example, if you took out a 5 year loan of $100,000 and the interest rate was 5%, the formula would look like this: $100,000 x 0.05 x 5 = $25,000.
While simple interest is the easiest to calculate, most lenders charge interest on an amortizing schedule. The monthly payments are fixed for this type of loan, but the lender applies the payments to your loan balance differently over time. Your initial payments will be interest-heavy, while your payments toward the end of your loan will go more towards the principal.
The amortizing interest formula is: (interest rate / number of payments that year) x remaining balance = interest paid that month. This type of interest must be calculated monthly to get an accurate idea of how much interest you will be paying.
For example, if you have a five year loan of $100,000 with a 5% interest rate, the formula would look like this: (0.05 / 12) x $100,000 = $416.67
If you’re borrowing money from a lender, you will have to pay back the money you borrow plus a fee for the service. This fee is called interest, and it can be calculated in many ways. If you are looking for a loan for your business, it is important to understand interest and how you may be charged for it.