Formula to Calculate Interest Rate
An interest rate formula is used to calculate 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 time period known as the principal amount over that lender 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 principle landed by the lender. The interest rate is directly proportional to risk as there is risk involved when a lender lends an amount to the borrower. It is also called compensation of opportunity lost.
In terms of investment, interest is paid on bank deposit investment like fixed deposit, recurring deposit, and even on the amount deposited in saving bank account. Bank pays interest half-yearly on saving account deposits. In contrast, for fixed deposit and recurring deposit, interest paid based on customer request, which could be monthly, quarterly, half annually, or yearly. And interest rate applied for one year is the annual interest.
There are two types of interest rate formula:-
- Simple Interest Formula
- Compound Interest Formula
Simple Interest Rate Formula
Simple interest 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 9 months and at an interest rate of 12%. Now, we will calculate the simple interest rate of interest to be paid to a lender on a principal amount of $1000.
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- Simple Interest
The interest payable 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 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 to understand loan and investment and take the decision. 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.
This article has been a guide to Interest Rate Formula. Here we discuss how to calculate Simple and Compound Interest Rate in Excel using practical examples and downloadable templates. You can learn more about financial analysis from the following articles –