What is Interest?
Interest is the premium someone is willing to pay to borrow your money and expressed as an annual percentage rate (APR). Inflation rates, length of the loan, liquidity and risk of default can all affect the interest rates.
The amount of interest you earn or pay depends on:
- The interest rate
- The amount of the loan
- How long it takes to repay
The borrower pays more if the rate is higher and a longer term loan.
How to calculate interests?
Simple Interest
Simple Interest=(Principal (P) x Interest Rate(r)) x Time(t)
= (P x r) x t
If you borrow $100 with an interest rate of 5% for a year, the interest to be paid is $5.
= (P x r) x t
= (100 x 0.05)1
= 5
Total amount to be paid back will be $105 including interests and principal.
Compound Interest
 | = | final amount |
 | = | initial principal balance |
 | = | interest rate |
 | = | number of times interest applied per time period |
 | = | number of time periods elapsed |
A=P (1 + r/n)^(nt)
If you borrow $100 with an interest rate of 5% for 5 years compounded monthly, the interest to be paid is $28.34.
A=P (1 + r/n)^(nt)
A=100 (1 + 0.05/12)^(12 x 5)
A=128.34
Total amount to be paid back will be $128.34 including the interest and principal.
Source: Dynamic Funds, BMO Global Asset Management, Investopedia
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