Compound interest formula
What is Compound Interest
Compound interest simply means to earn interest on interest. If you're to start off with 100 dollars and receive an interest of 10 percent per month, after the 1st month you would have $110, after the 2nd month you would have $121, after the 3rd month you would have $133.10. As you could see, your money increases at an accelerating rate as you earn interest on interest; that is what is meant by the power of compound interest.
Flat charge
The lender simply charges you a set fee to borrow money. This form of interest is almost never used today although it isn't uncommon for financial institutions to charge an administration or set up fee when you borrow money.
Simple interest
Simple interest is calculated by multiplying the amount of your debt by the interest rate. This form of interest is often charged by family or friends and not by financial institutions. It is not effected by the repayment period. It is a fairly straight forward calculation, if you borrow $5,000 at 11 percent simple interest then you would repay $5,550 ($5,000 plus $550 (11 % of $5,000).
Complex interest
Complex interest formula is calculated by multiplying the amount of debt outstanding by the interest rate. The difference here is that the interest formula rate is applied to the debt at a specific point in time and the amount you pay will depend on the amount of your original loan that remains outstanding. Commercial lenders charge this type of interest.If you borrow $5,000 at 11 percent per annum for 36 months your monthly payment would be $160.35. At the end of the 1st month you would owe $40.68 interest ($5,000 x 10% /12 months). At the end of the 2nd month your loan balance would be $4,881.31 ($5,001 + $41.67 - $161.32). Your interest charge for the 2nd month would be $40.52 ($4,880.24 x 10% / 12 months). By the end of the loan the total interest you would pay is equal to $818.08.
Compound interest
Compound interest is the interest charged on any unpaid interest. This is the most expensive type of interest of all. Commercial lenders charge this type of interest. The following example explains how to use compound interest formula to calculate the total cost of borrowing if interest is calculated as compound interest. Use the same example as above, except you don't make any payments for 6 months. At the end of the first month you would owe $5,041.62 ($5,000 plus unpaid interest of $41.51). At the end of the 2nd month you would owe $5,023.58 ($5,000 plus $40.27 plus $42.02 interest). In the 2nd month you paid $0.35 interest on the unpaid interest from the 1st month. At the end of 6 months you will owe $5,265.25 ($5,000 you borrowed plus unpaid interest of $245.16). The total cost of borrowing with compound interest, if you then made payments for 36 months, would be $859.45.
There csn be a significant difference in your total cost of borrowing depending on whether compound interest formula or some other type of interest calculation is used. Make certain that you know what rate and what type of interest you are being charged on your debts - take interest in the interest you pay!
Comments
No comments yet. Be first!