Formula to Calculate Interest Rate
An interest rate formula calculates the repayment amounts for loans and interest over investment on fixed deposits, mutual funds, etc. It is also used to calculate interest on a credit card.
When a lender lends any amount to the borrower for a specific period, known as the principal amount over that lender’s charge interest, that percentage of principle is known as the interest rate. In simple words, the interest rate is the rate at which the lender charges the amount over the principal landed by the lender. The interest rate is directly proportional to risk, as risk is involved when a lender lends an amount to the borrower. It is also called compensation for an opportunity lost.
In terms of investment, interest is paid on bank deposit investments like fixed, recurring, and even on the amount deposited in a savings bank account. Bank pays interest half-yearly on saving account deposits. In contrast, for fixed and recurring deposits, interest is paid based on customer request, which could be monthly, quarterly, half annually, or yearly. And the interest rate applied for one year is the annual interest.
There are two types of interest rate formula:-
- Simple Interest FormulaSimple Interest FormulaSimple Interest (SI) is a way of calculating the amount of interest that is to be paid on the principal and is calculated by multiplying the principal amount with the rate of interest and the number of periods for which the interest has to be paid.
- Compound Interest Formula
Table of contents
- An interest rate formula computes loan payback amounts and interest earned on fixed deposits, mutual funds, and other investments. It is also used to calculate credit card interest.
- Simple interest and compound interest formulas are the two types of interest rate formulas.
- An interest rate formula assists in understanding and deciding on loans and investments. Financial institutions such as banks compute interest using the compound interest formula. CAGR, or compound annual growth rate, is commonly employed in financial applications where a single period’s growth must be determined.
Simple Interest Rate Formula
Simple interestSimple InterestSimple interest (SI) refers to the percentage of interest charged or yielded on the principal sum for a specific period. is levied when a loan is borrowed for one year or less. Simple interest is generally applied for the short term.
In simple in it also written as,
Simple Interest rate = (P*R*T)/100
A borrower borrows $1000 from a lender for nine months at an interest rate of 12%. Now, we will calculate the simple interest rate to be paid to a lender on a principal amount of $1000.
- Simple Interest
The interest payableInterest PayableInterest Payable is the amount of expense that has been incurred but not yet paid. It is a liability that appears on the company's balance sheet. to the lender is $90, and the principal amount is $1000. The total amount payable to a lender is $1090.
Compound Interest Formula
Compound interest Compound Interest Compound interest is the interest charged on the sum of the principal amount and the total interest amassed on it so far. It plays a crucial role in generating higher rewards from an investment.is called “interest on interest.” It is calculated on the principal amount, and of the time period, it changes with time.
The time period, it changes with time.
- P = Principle
- i= Annual interest rate
- t= number of compounding period for a year
- i = r
- n = number of times interest is compounded per year
- r = Interest rate (In decimal)
Total amount payable to be lender = P (1+i) t
A borrower took a personal loan from ABC bank, he borrowed $5000 amount from a bank at the interest rate of 10%, for a time period of 5 years, compounded yearly then compound interest will be:
- Compound Interest
So from the above calculation of Compound Interest will be:
Use and Relevance
- An interest rate formula helps one understand loans and investments and decide. These days financial bodies like banks use the Compound interest formula to calculate interest. Compounded annual growth rate, i.e., CAGR, is used mostly for financial applications where single growth for a period needs to be calculated.
Frequently Asked Questions (FAQs)
The real interest rate is the loan rate adjusted for inflation using the GDP deflator. The terms and circumstances related to loan rates vary by nation, making them difficult to compare.
A real interest rate is an interest rate that has been adjusted for inflation. To find the real interest rate, subtract the nominal from the inflation rate. In mathematical terms, the real interest rate equals the nominal interest rate minus the inflation rate.
Nominal interest rates cannot be negative, but actual interest rates can. Real interest rates fall when the inflation rate exceeds the nominal interest rate. Nominal interest rates could not be negative because banks would pay you to borrow money if they charged a negative nominal interest rate.
This article has been a guide to Interest Rate Formula. Here we discuss how to calculate Simple and Compound Interest rates in Excel using practical examples and downloadable templates. You can learn more about financial analysis from the following articles –
- Daily Compound InterestDaily Compound InterestDaily Compound Interest refers to the total interest amount, including the amount of interest earned on the initial principal & the amount of interest earned daily. It might be higher than Monthly or Quarterly Compound Interest due to the high compounding frequency.
- Nominal Interest Rate FormulaNominal Interest Rate FormulaNominal Interest rate refers to the interest rate without the adjustment of inflation. It is a short term interest rate which is used by the central banks to issue loans.
- Rate Function in Excel