how to calculate interest rate on a loan

how to calculate interest rate on a loan

How to Calculate Interest Rate on a Compensating Balance & Installment Loan

The compensating balance, loan interest rate, and principal amount will be listed on your loan application. You will need to calculate the loan's effective rate on your own.

When you take out a loan from a bank, it is typically an installment loan -- that is, a loan you pay off in several installments. Depending on your credit history, you may be required to keep a deposit of funds at the bank to qualify for the loan. This deposit is known as a compensating balance and reduces the bank's total risk in making a loan. If you fail to repay the loan, the bank can seize the compensating balance. The effective interest rate of a compensating balance installment loan is higher than a regular loan because you must tie up a portion of your loan as the compensating balance.

1. Review the loan application to find the principal amount of your loan, the stated interest rate of the loan, and the amount of the necessary compensating balance.

2. Multiply the loan principal by the stated interest rate to calculate the nominal interest due on the loan. A $100,000 loan with a 5 percent interest rate would have nominal interest of $5,000.

3. Record the compensatory balance required from your loan. The bank will record the necessary compensatory balance on your loan application.

4. Subtract the compensatory balance from the total principal to calculate the available balance. If your total loan is for $100,000 and the compensatory balance is $5,000, your available balance is $95,000.

5. Divide the nominal interest due by the available principal to calculate the effective interest rate of your compensatory balance installment loan. Example: Assume the interest rate on a compensatory balance loan has an interest rate of 5 percent, a principal of $100,000, and a compensatory balance of $5,000. Effective interest rate = $5,000/($100,000 - $95,000) = $5,000/$95,000 = 0.0526 = 5.26 percent. The effective rate is higher than the stated interest rate because of the compensatory balance.

How To Calculate Interest Rate On A Loan

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How To Calculate Interest Rate On A Loan

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How to calculate interest rate on loan amount

Updated: 4 days ago

Lists of bank debtors are growing. To avoid troubles with the banks, borrowers need to know how to calculate interest rate on loan amount and their opportunities in this regard. We will reveal some useful secrets to you in our post below.

Nigerians often take loans. In all cases, the reason is one - right now they need money and there is no way to get it except as in a form of a loan. If you want to buy the cherished thing, to have an unforgettable vacation, organize a wedding, get an education or apply for medical services, the bank will give you money to fulfill any of your whims.

Use this possibility but remember that commercial organizations don’t make gifts and you will have to turn money back. Banks try to protect their interests, minimize risks, requiring the borrower to confirm the return of the debt, provide the collateral. In other words, the fewer opportunities a future debtor has, the higher the risk of the lender and the rate on the loan. Manipulating the rates and terms of the loans, banks constantly offer more and more credit products creating the illusion of choice.

Remember: knowing how to calculate interest rate on a loan will help to allocate properly your expenses and not to overpay.

Before registering a loan, it is necessary to find out about the real sum of overpayment. The person assumes the amount and term of the loan and the bank tells about the rate, the scheme for calculating the interest, and the presence of additional payments.

Types of interest calculation schemes

Most of the banks have two schemes for loan repayment for borrowers: simple interest and compound interest.

It is worth noting that it is difficult to use a traditional calculator to make such calculations and it's easy to make a mistake. It's better to use Excel spreadsheets or special loan calculator (they are now available on sites of almost all the banks you may be interested in).

A simple scheme means that the interest is always calculated only on the initial amount for each period of time.

Example: a loan of $5000 with 20% interest per annum. According to the simple interest scheme, in first, second, and any other year the interest will be $1000. To find out the interest for N years, simply multiply the profit with N.

In this case, $5000 is the principal amount (P), 20% is our rate (R), 2 years is out period of the loan (t), the final amount of the loan with the interest will be (A). So, to calculate A we need to use the formula A=P(1+rt) where r=R/100. Taking our example, A= 5000(1+0.2*2)=7000.

The compound scheme means that the interest on loan is charged for each period taking into account the initial amount and all interest received before.

Example: a loan of $5000 with interest 20% per annum. In the first year, the interest will be $5000*20% = $1000, in the second ($5000 + $1000) * 20% = $1200, in the third ($5000 + $1000 + $1200) * 20% = $1,440 and so on.

Every time bank wants to "scroll9quot; its money several times through an investment tool, it faces the compound percentage. The profit received in the first round is reinvested and the income charges to a larger amount.

It is useful to know: the difference between simple and compound interest at first glance seems to be not so great. But the more time passes, the more obvious is the advantage of simple interest.

There is also Euribor (European Interbank Offered Rate), which is fixed in the loan agreement for a specified period during which the rate does not change. For example, a six-month Euribor is specified in the client contract. Then the rate changes every six months.

What else affects the interest on the loan?

Often people start to compare offers of banks and choose those where the interest rate on the loan is the lowest. But in fact, it turns out that the real amount that should be paid by the client is much higher than declared in the advertisement of the bank.

In addition, banks attract potential borrowers in the streets, shopping centers, markets, beckon and call to take a loan without interest, and bank managers "forget9quot; to inform about the additional services that the bank renders and which will have to be paid. But we are adults, so do not believe in fairy tales and understand that commercial organizations will not work for free. Therefore, if you are offered an interest-free loan, be prepared to pay for various bank services that you can’t refuse.

The responsibility of the bank should include the borrower's notification of the full cost of the loan and the interest rate. These data should be provided not only in the payment schedule but also on the first page of the loan agreement.

All payments for the credit organization, insurance company, and other institutions are included in the calculation if this follows from the terms of the contract. Making a partial early repayment allows the client to make a choice about what will be reduced: the period or amount of payments.

It is useful to know: it is more advantageous to reduce the duration of loan payments. It is simple to calculate the total overpayment: just sum the amount of interest for the crediting period, all insurance and additional payments.

Bank penalties may be charged for late repayment of the loan.

Insurance premiums are levied for insurance services which are not obligatory in most cases. They are present not in all types of lending and may be optional. However, in deals of mortgages and car loans, in most cases, apartment or car insurance is a prerequisite for granting a loan. This is understandable: the bank wants to reduce its risks in the event of a loss or a significant reduction in the value of the pledged property.

It is useful to know: a number of credit organizations force clients to compile the policy declaring that this is an obligatory procedure and sending people to partnership insurance company with unprofitable tariffs. In such cases, it is better to refuse to obtain a loan or apply for the protection of your rights in court.

Banks are required to provide full information about all payments on the loan. In addition, some commissions on individuals are recognized by the court as illegal. Such payments are often included in the text of the contract in small print or in the form of a reference to the rates of the credit institution. It is unacceptable! Be careful.

Other services of the bank may be provided in the contract but not directly relate to the performance of the loan (for example, mailing or transfer of funds).

So, comparison of credit offers of different banks should be made not only on the basis of the size of the interest rate. Also, the repayment schemes, insurance, and additional payments arising from the contract should be considered. Own calculations, the help of the Internet, and specialists from financial organizations can help you.

After you make the last payment and repay the loan, take in the bank a certificate with a signature and seals stating that the loan has been fully paid. This is necessary in order to avoid the situation when there are some unpaid small amounts about which you have not been notified by the bank and for which the interest will be charged.

Then a few months later, when you are sure that you have repaid the loan, this amount will be presented to the mandatory payment.

Close the account in the bank, write the appropriate document. Account maintenance can cost money. You do not need an account anymore. Why should you pay?

Keep and do not lose documents on your credit history even after the loan is closed. This is a loan agreement with attachments, receipts for payment (it is desirable to make copies - receipts fade with time) and all other documents that are connected with your loan.

We hope that it was useful for you to find out how to calculate interest rate on loan. If life circumstances forced you to borrow money, be extremely careful and then you will not have to face financial problems. Good luck!

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How to Calculate the Interest Rate on a Loan

by Louise Balle

The interest rate on a standard loan, also called the APR (annual percentage rate) is what a bank charges you for the benefit of using its money. In most cases, the bank has to disclose the interest rate when it first gives you the money. But if for some reason you don't know the interest rate on a loan, you can figure it out as long as you have a few other key pieces of information about the loan on hand.

Gather key details about the loan, including the total interest charge you have to pay for the year, the principal (amount you borrowed), the frequency of payments and the length of your loan.

Enter these details into a formula to determine the interest rate (APR). The formula is 2*n*I/(P[T + 1]) where n is the number of payment periods for a year (12 for a standard monthly loan), I is the total interest charged over the course of the loan, P is the principal balance borrowed initially and T is the total number of payments on the loan.

Perform the calculation after inserting the figures for the loan in question. Say, for example, you have to pay $100 in interest over the course of the loan on a $1,000 loan that lasts for three years and requires monthly payments. The formula with figures filled in is 2*12*100/(1,000[36+1]), which equals about .065 or a 6.5 percent interest rate.

Louise Balle has been writing Web articles since 2004, covering everything from business promotion to topics on beauty. Her work can be found on various websites. She has a small-business background and experience as a layout and graphics designer for Web and book projects.

When you take out a loan, whether it’s a car loan, home loan or credit card, you’ll have to pay back both the amount you borrowed and interest on top of it. But what do we mean by that?

Well, essentially, interest is a fee you pay for using someone else’s (usually the bank’s) money. It’s how lenders make profit from giving out loans - after all, they’re not in it out of the goodness of their hearts.

Usually the repayments you make on a loan will be made up of two parts: the part that reduces your balance to pay off your loan, and the part that covers the interest on the loan.

Factors that affect how much interest you pay

You’ll need to know a few basic facts about your loan before calculating how much interest you’ll pay. All of these things should be freely available to you before you take on the loan - you’ll find them on Mozo’s loan comparison pages - and it’s a good idea to know them all anyway, even if you’re not trying to calculate interest.

This is the amount you’re looking to borrow. But it’s not as simple as deciding how much you want - you should really be focusing on how much you can realistically afford to pay back. To work it out, consider your budget on all levels - yearly, monthly and weekly - and think about any life changes you might encounter (are you about to have kids? Make a big move?). Mozo also has some great, free resources to help you straighten out just how much you can borrow, like our:

How long will you be repaying your loan? Shorter loan terms will generally mean higher repayments, but less interest in the long run, while longer terms will lower monthly repayments, but cost more in interest over the entire life of the loan.

For example, our personal loan repayment calculator shows that on a loan of $20,000 at 8.75% p.a. you would pay:

$634 each month, adding up to $2,812 in interest over 3 years, or

$413 each month, adding up to $4,765 in interest over 5 years.

On many loans, you’ll have the option to make repayments weekly, fortnightly or monthly. Which one you choose will depend on your budgeting style. More repayments means less interest, because of the effects of compounding, so weekly repayments will save you some money. But before you commit to a weekly repayment schedule, make sure that your budget can meet it!

When you make your repayment, not all of it goes to paying off your loan, as such. A certain amount will go towards paying the interest first and then what’s left chips away at your loan principal. Because the amount of interest you pay depends on what your principal is, to calculate ongoing interest costs, you’ll need to know what amount you’re making in repayments.

When calculating interest on your loan, remember to use the basic annual interest rate and not the comparison rate to get accurate numbers. The comparison rate takes into account fees and charges as well as interest, so if you use it, you will get a higher amount of interest than you should.

Calculating interest on a car, personal or home loan

These loans are called amortizing loans - which means that the mathematical whizzes at your bank have worked them out so that you pay a set amount each month and at the end of your loan term, you’ll have paid off both interest and principal.

You can use an interest calculator to work out how much interest you’re paying all up, or, if you’d rather do it by hand, here’s how:

1. Divide your interest rate by the number of payments you’ll make in the year (interest rates are expressed annually). So, for example, if you’re making monthly payments, divide by 12.

2. Multiply it by the balance of your loan, which for the first payment, will be your whole principal amount.

This gives you the amount of interest you pay the first month.

So for example, on a personal loan of $30,000 over a period of 6 years at 8.40% p.a. and making monthly repayments:

Because you’ve now begun to pay off your principal, to work out the interest you pay in the following months, you need to first calculate your new balance. So:

1. Minus the interest you just calculated from the amount you repaid. This gives you the amount that you have paid off the loan principal.

2. Take this amount away from the original principal to find the new balance of your loan.

To work out ongoing interest payments, the easiest way is to break it up into a table. So using the above example, your calculations might look like this:

Keeping in mind that doing the calculations yourself means slight discrepancies due to rounding and human error, this should give you a pretty good idea of what you’re paying in interest each month.

Taking out a home loan? You might have the option to choose between a principal and interest loan or an interest only loan.

As the name suggests, if you choose to take out an interest only loan then your whole monthly payment will be going toward interest. You won’t be chipping away at your principal amount, which means the amount of interest you pay won’t change. In the above example, you’d pay only $210 in interest each month, and then at the end of the 6 years, you’d have a lump sum of $30,000 to pay in full.

Calculating interest on a credit card

It’s a good idea to think of using a credit card as taking out a loan - it’s money that is not yours, you’re paying to use it, and it’s best that you pay it back as soon as you can.

For the most part, working out how much you pay in interest on your credit card balance works much the same way as for any other loan. The main differences are:

  • your basic repayment is a minimum amount set by your credit card company. It might be a set dollar amount, similar to any other loan, or it might be a percentage of your balance. It’s best to pay more than the minimum amount, because often, it doesn’t even cover the cost of interest. Paying only the minimum is how you wind up with a massive credit card debt.
  • if you make purchases on your card before paying off previous amounts, it will be added to your balance and you’ll pay interest on the whole lot. This will change your minimum payment amount as well, if the minimum payment is based on a percentage of your balance.

It’s always a good idea to pay off as much of your credit card balance as you can, as early as you can - that way, you avoid getting hit by high interest rates! So when you’re calculating your interest, just remember to use the right amount for your repayment value and add any extra purchases onto your balance, and the above method should work to calculate your interest.

Use our interest rate calculators

If all of that looks like way too much math to stomach, or if you don’t have time to become a spreadsheet expert, you can use our handy financial calculators to do the work for you. Our repayments calculators will tell you the repayment you’ll make on a monthly, fortnightly or weekly basis, and give you the total amount of interest you’ll wind up paying on your car, personal or home loan. And our credit card debt payment calculator will show you how long it will take you to pay off a credit card debt, plus how much you’ll pay in interest and fees.

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