Basically, interest is a fee that is charged for money that is borrowed. This also applies to money that you put away in your savings account because this essentially involves you lending your money to the bank. The bank pays you interest for the money.
Interest calculators are helpful in determining the interest amounts as well as the final balances. The calculators calculate the interest on both the fixed principal and the additional periodic contributions too.
Calculating the Interest
A rate (expressed as a percentage), called the interest rate, is used to determine the amount charged to borrowers by lenders. The rates are mostly annual even though either monthly or daily rates can be used.
Interest calculators can be found on many websites and can be used free of charge. Those who intend to can create their own interest calculators using a custom calculator widget that is available on the Calconic Website.
Types of Interest
When you’re paying back a loan, you will have to pay back the total sum of the amount you borrowed and the interest. It is important for one to learn how to calculate interest to help build upon your investment. There are two types of interest: Simple and compound interest.
For you to get a clear understanding, well use both methods to calculate a interest for the same amount of principal invested for the same time duration.
Person X deposits $100 in a bank that earns a 5% annual interest. How much will the investment be after one year?
- Simple Interest
Formula: P x r x t = I
100 x 5/100 x 1
- Compound Interest
Formula: A = P (1 + r/n) ^ nt
A= 100 (1+ 0.05/12) ^ (12 x 1)
A= 100 (1.004167) ^ (12)
A= 100 (1.051)
A= $ 105.117
Interest = $ 105.117 $ 100
= $ 5.12
As you can see, the compound interest is slightly higher. This amount gets even higher with higher principal amounts and longer holding times.
Factors Affecting How Much Interest You Earn
There are several factors that directly affect the total interest paid on any loan. They include:
- The Interest Rate
- The Principal Amount
- The Loan Term
- The Repayment Schedule
- The Repayment Amount
Why Interest Rates Fluctuate
The various factors that cause fluctuation of interest rates are:
The actual interest rate is affected by inflation to bring about the nominal rate. The nominal rate refers to the total sum of the general inflation and the real rate of interest.
A higher inflation rate translates to higher interest rates.
ii. Government and Economic Policies
The government and the central banks usually set the monetary policy. This, in turn, affects the interest rates causing them to fluctuate.
The government can, for example, decide to lower the interest rates to promote spending and boost the economy.As a result of the lowered interest rates, people will be inclined to spend more on things that require borrowing such as car loans, mortgages or small business loans.
iii. Individual Borrower Risk
Interest rates can fluctuate depending on the perceived risk of individual borrowers. Lenders are more hesitant about lending their money to borrowers who have a history of missed credit card payments or bankruptcy. As a result, the lender will charge a higher interest rate to protect themselves from the increased risk of likelihood of default.