How to Calculate Compound Interest Payments
Understand the meaning of interest., Define compound interest., Learn the formula for compound interest., Understand the Rule of 72.
Step-by-Step Guide
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Step 1: Understand the meaning of interest.
Interest can be calculated for loans or for investments.
For a loan, interest is the amount paid to the creditor for granting the loan to you.
For an investment, interest is income that the investment earns.Interest for a loan is usually expressed as an annual percentage rate, which is the annual rate that is charged for borrowing the money.Interest on an investment is usually expressed as a percentage.The two main types of interest that can be applied to loans are simple and compound interest.
Simple interest is calculated by multiplying the interest by the principal by the number of periods.
Compound interest, however, is the most commonly used method of applying interest to a loan or investment. -
Step 2: Define compound interest.
Compound interest is interest calculated on the original principal plus interest calculated on the accumulated interest from previous accounting periods.
The rate at which the interest accrues, or accumulates over time,depends on how often the interest is compounded.
Interest can be compounded annually, monthly or quarterly.Compound interest is not beneficial for those in debt.
If a person carries a credit card balance on a high-interest credit card for which the interest is compounded monthly, the interest payments alone could be hundreds of dollars per month.Compound interest is advantageous to investors, because the interest that is earned each accounting period gets added back to the principal and earns more money for the investor. , The annual compound interest formula is P(1+i)n−P{\displaystyle P(1+i)^{n}-P}.
In this formula, P = Principal, i = annual interest rate in percentage terms, and n = number of compounding periods.
If the interest is compounded more than once per year, such as monthly (12 times per year) or quarterly (four times per year), the formula must be adjusted,The formula for compound interest that is compounded multiple times per year is −P{\displaystyle
-P}.
In this formula, P = Principal, i = interest rate, n = number of compounding periods, and t = the number of years for which the money is invested or borrowed., You can use the rule of 72 to figure out how long it will take to double your money on an investment that is earning compound interest.
Divide 72 by the annual interest rate your investment is earning.
The answer will tell you how many years it will take for your investment to double in value.For example, if your investment is earning a 3 percent interest rate, calculate how long it will take to double your money using the equation 72/3=24{\displaystyle 72/3=24}.
In 24 years, your investment will have doubled in value.
Interest rates on investments do fluctuate, so the rule of 72 should be used as a tool for estimating the future value of your investments. -
Step 3: Learn the formula for compound interest.
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Step 4: Understand the Rule of 72.
Detailed Guide
Interest can be calculated for loans or for investments.
For a loan, interest is the amount paid to the creditor for granting the loan to you.
For an investment, interest is income that the investment earns.Interest for a loan is usually expressed as an annual percentage rate, which is the annual rate that is charged for borrowing the money.Interest on an investment is usually expressed as a percentage.The two main types of interest that can be applied to loans are simple and compound interest.
Simple interest is calculated by multiplying the interest by the principal by the number of periods.
Compound interest, however, is the most commonly used method of applying interest to a loan or investment.
Compound interest is interest calculated on the original principal plus interest calculated on the accumulated interest from previous accounting periods.
The rate at which the interest accrues, or accumulates over time,depends on how often the interest is compounded.
Interest can be compounded annually, monthly or quarterly.Compound interest is not beneficial for those in debt.
If a person carries a credit card balance on a high-interest credit card for which the interest is compounded monthly, the interest payments alone could be hundreds of dollars per month.Compound interest is advantageous to investors, because the interest that is earned each accounting period gets added back to the principal and earns more money for the investor. , The annual compound interest formula is P(1+i)n−P{\displaystyle P(1+i)^{n}-P}.
In this formula, P = Principal, i = annual interest rate in percentage terms, and n = number of compounding periods.
If the interest is compounded more than once per year, such as monthly (12 times per year) or quarterly (four times per year), the formula must be adjusted,The formula for compound interest that is compounded multiple times per year is −P{\displaystyle
-P}.
In this formula, P = Principal, i = interest rate, n = number of compounding periods, and t = the number of years for which the money is invested or borrowed., You can use the rule of 72 to figure out how long it will take to double your money on an investment that is earning compound interest.
Divide 72 by the annual interest rate your investment is earning.
The answer will tell you how many years it will take for your investment to double in value.For example, if your investment is earning a 3 percent interest rate, calculate how long it will take to double your money using the equation 72/3=24{\displaystyle 72/3=24}.
In 24 years, your investment will have doubled in value.
Interest rates on investments do fluctuate, so the rule of 72 should be used as a tool for estimating the future value of your investments.
About the Author
Diana Green
Specializes in breaking down complex hobbies topics into simple steps.
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