computing interest. interest cost is a major expense varies with interest rate varies with the...
TRANSCRIPT
COMPUTING INTEREST
INTEREST COSTIS A MAJOR EXPENSE
VARIES WITH INTEREST RATE
VARIES WITH THE METHOD USED TO CALCULATE INTEREST
METHODS OF CALCULATING
INTEREST
SIMPLE INTEREST
REMAINING BALANCE
ADD ON METHOD
Simple interestVery Simple
Used Primarily on Short Term Loans
Simple Interest Example
$1000 borrowed for 1 year at 5% interest
$1000 x .05 = $50 interest charge
$1050 to be paid back at the end of the loan
Remaining Balance Method
Used when several payments are to be made
Interest is charged only on the remaining principal balance
Remaining Balance Method
•$1000 borrowed for 4 years at 8% interest.
•The $1000 will be paid back in yearly principal installments of $250.
YEAR 1:
$1000 X .08 (interest rate) = $80 interest cost
+$250 Principal Payment $330 Annual Payment
Remaining Balance Method
Remaining Balance Method
YEAR 2:
$750 X .08 (interest rate) = $60 interest cost
+$250 Principal Payment $310 Annual Payment
Remaining Balance Method
YEAR 3:
$500 X .08 (interest rate) = $40 interest cost
+$250 Principal Payment $290 Annual Payment
Remaining Balance Method
YEAR 4:
$250 X .08 (interest rate) = $20 interest cost
+$250 Principal Payment $270 Annual Payment
Remaining Balance Method
•$200
•Over a Four-Year Period
ADD ON METHOD
Interest charged on full principal amount for the entire life of the loan.
Total interest amount is added to principal and divided into even payments
Add On Interest Example
$1000 borrowed for 4 years at 8%
interest.
Step 1: Calculate the total interest paid over the lifespan of the loan
$1000 (principal amount) X
.08 (interest rate)x
4 (years) $320 Interest Charge
This $320 is the Interest Charge (or the total amount of interest paid over the lifespan of the loan)
Add On Interest Example
Step 2: Add the interest charge to the principal amount
$1000 (principal amount) +
$320 (Interest Charge) $1320 (Total amount paid)
Add On Interest Example
Step 3: Divide total amount paid by the total number of payments
$1320 (total amount paid) /
4 (years)$330 Yearly Payment
Notice that the total Interest Charge is $120 higher using the Add-On method than with the Simple Interest Method.
Add On Interest Example
Calculating APR (using Add-On Method)
R = 2C X 100L (P + A)
Formula Key:
R = Annual Percentage Rate C = Total Interest Cost
L = Length of Loan in Years P = Principal Amount Borrowed
A = Payment Amount Each Period
Add On Interest Example
R = 2($320) X 1004 (1000 + 330)
Add On Interest Example
R = 12.03%
•This APR is MUCH higher than the original 8% interest originally charged
•(4.03% more)