FINDING INTEREST
Borrowing money has a cost. Interest , I, is the cost of using someone else's money. The amount of interest paid on a loan or charge account should be clearly understood. To determine this amount, you need to know the following.
1. Principal, P Amount of the loan.
2. Interest Rate, R Percent of interest charged or earned. Remember that a percent can also be expressed as a decimal or a fraction. The symbol for percent is %.
3. Time, T Length of time for which interest will be charged, usually expressed in years or parts of a year.
Simple InterestOn single-payment loans, interest is usually simple interest . The formula for computing simple interest is shown below.
Interest = Principal × Rate × Time
I = P × R × T
A simple interest rate of 12 percent per year means you are paying 12 cents for each dollar you borrow for a year. At this rate, if you borrow $1, you pay 12 cents in interest. If you borrow $2, you pay 24 cents. If you borrow $10, you pay $1.20, and so on.
Borrowing money has a cost. Interest , I, is the cost of using someone else's money. The amount of interest paid on a loan or charge account should be clearly understood. To determine this amount, you need to know the following.
1. Principal, P Amount of the loan.
2. Interest Rate, R Percent of interest charged or earned. Remember that a percent can also be expressed as a decimal or a fraction. The symbol for percent is %.
3. Time, T Length of time for which interest will be charged, usually expressed in years or parts of a year.
Simple InterestOn single-payment loans, interest is usually simple interest . The formula for computing simple interest is shown below.
Interest = Principal × Rate × Time
I = P × R × T
A simple interest rate of 12 percent per year means you are paying 12 cents for each dollar you borrow for a year. At this rate, if you borrow $1, you pay 12 cents in interest. If you borrow $2, you pay 24 cents. If you borrow $10, you pay $1.20, and so on.
Suppose you borrow $100 (P) at 12 percent (R) for one year (T). To calculate the amount of interest, first change 12 percent to a decimal, 0.12. Using the formula, the interest is $12.
I = P × R × T
I = $100 × 0.12 × 1 = $12
If you borrow $100 at 12 percent for two years, you pay twice as much interest, or $24.
I = $100 × 0.12 × 2 = $24
If you borrow the money for three years, you pay $36, and so on.
Time in Months Your loan may be for one month instead of one year. How is simple interest calculated for less than a year? The amount of interest is based on the portion of the year. There are 12 months in a year, so one month is one-twelfth of a year, regardless of the number of days in the particular month.
If you borrow $100 at 12 percent for one month, the interest is
I = P × R × T
I = $100 × 0.12 × 1 = $12
If you borrow $100 at 12 percent for two years, you pay twice as much interest, or $24.
I = $100 × 0.12 × 2 = $24
If you borrow the money for three years, you pay $36, and so on.
Time in Months Your loan may be for one month instead of one year. How is simple interest calculated for less than a year? The amount of interest is based on the portion of the year. There are 12 months in a year, so one month is one-twelfth of a year, regardless of the number of days in the particular month.
If you borrow $100 at 12 percent for one month, the interest is
Time in Days A loan may be for a certain number of days such as 30, 60, or 90 days. To make the computation easy, a year is often considered as 360 days. The interest on a loan of $100 at 12 percent for 60 days is $2.
Maturity DatesThe date on which a loan must be repaid is the maturity date . When the time of the loan is stated in months, the date of maturity is the same day of the month as the date on which the loan was made. A one-month loan made on January 15 will be due February 15. A two-month loan will be due March 15, and so on.
When the time is in days, you must count the exact number of days to find the date of maturity. First, determine the number of days remaining in the month when the loan was made. For example, if the loan was made on January 10, there would be 21 days counted in January, because there are 31 days in January. Then add the days in the following months until the total equals the required number of days.
Suppose you want to find the date of maturity of a 90-day loan made on March 4. First find the number of days remaining in March. Then add the days in the following months until you reach 90 days. In this case, the due date is June 2. Figure 18-1 illustrates the process.
Maturity DatesThe date on which a loan must be repaid is the maturity date . When the time of the loan is stated in months, the date of maturity is the same day of the month as the date on which the loan was made. A one-month loan made on January 15 will be due February 15. A two-month loan will be due March 15, and so on.
When the time is in days, you must count the exact number of days to find the date of maturity. First, determine the number of days remaining in the month when the loan was made. For example, if the loan was made on January 10, there would be 21 days counted in January, because there are 31 days in January. Then add the days in the following months until the total equals the required number of days.
Suppose you want to find the date of maturity of a 90-day loan made on March 4. First find the number of days remaining in March. Then add the days in the following months until you reach 90 days. In this case, the due date is June 2. Figure 18-1 illustrates the process.
Installment InterestWhen you borrow money, you usually make several partial payments instead of one large single payment. A loan that you repay in partial payments is an installment loan (or consumer loan). Each payment is an installment.
Banks, credit unions, and consumer finance companies all offer installment loans. With an installment loan, the bank gives the borrower a schedule of payments. It shows how much the borrower must pay each month.
With some loans, the lender adds the amount of the interest to the amount you borrow. You sign a promissory note for the total amount. You then repay the note in equal monthly installments.
Suppose you borrow $100, sign a note for $110, and agree to repay the loan in 12 monthly installments of $9.17 each. If you had borrowed $100 for one year and paid $110 at maturity, the interest rate would be 10 percent ($10 ÷ $100 = 0.10).
However, you paid off just part of the loan each month. You had the use of the entire $100 for one month and a smaller amount each succeeding month as you repaid the loan. In this case, the true interest rate amounts to 18.5 percent.
Amortization Schedules On some installment loans, interest is calculated on the amount that is unpaid at the end of each month. The payment table of principal and interest over time is called an amortization schedule.
Suppose that a person obtained a loan for $1,000 and agreed to repay $100 per month. The lender applies the payment to principal and interest. The borrower makes payments each month on a level payment schedule. Figure 18-2, on page 464, shows this amortization schedule.
Amortization schedules show that when loans are first taken, a larger percentage of the payments go to interest.
At the end of the schedule, more goes to principal. For example, the second payment includes more than $9 in interest and the tenth payment includes only $1.57 in interest. Only $90.90 from the second loan payment is applied to the principal. The tenth payment includes more than $98 in principal.
Banks, credit unions, and consumer finance companies all offer installment loans. With an installment loan, the bank gives the borrower a schedule of payments. It shows how much the borrower must pay each month.
With some loans, the lender adds the amount of the interest to the amount you borrow. You sign a promissory note for the total amount. You then repay the note in equal monthly installments.
Suppose you borrow $100, sign a note for $110, and agree to repay the loan in 12 monthly installments of $9.17 each. If you had borrowed $100 for one year and paid $110 at maturity, the interest rate would be 10 percent ($10 ÷ $100 = 0.10).
However, you paid off just part of the loan each month. You had the use of the entire $100 for one month and a smaller amount each succeeding month as you repaid the loan. In this case, the true interest rate amounts to 18.5 percent.
Amortization Schedules On some installment loans, interest is calculated on the amount that is unpaid at the end of each month. The payment table of principal and interest over time is called an amortization schedule.
Suppose that a person obtained a loan for $1,000 and agreed to repay $100 per month. The lender applies the payment to principal and interest. The borrower makes payments each month on a level payment schedule. Figure 18-2, on page 464, shows this amortization schedule.
Amortization schedules show that when loans are first taken, a larger percentage of the payments go to interest.
At the end of the schedule, more goes to principal. For example, the second payment includes more than $9 in interest and the tenth payment includes only $1.57 in interest. Only $90.90 from the second loan payment is applied to the principal. The tenth payment includes more than $98 in principal.
FINANCE CHARGESBefore you borrow money or charge a purchase, you should know the exact cost of using credit. Three things to consider are the annual percentage rate, the total dollar charges, and the alternative sources of credit.
Annual Percentage RateThe annual percentage rate (APR) is a disclosure required by law. It states the percentage cost of credit on a yearly basis. All credit agreements, whether for sales credit or loan credit, require disclosure of the APR.
In addition to interest, the APR includes other charges that may be made. Service fees involve the time and money it takes a creditor to investigate your credit history, process your loan or charge account application, and keep records of your payments and balances.
The costs of collecting from those who do not pay their accounts may also be passed on to other borrowers. Uncollectible accounts are frequently referred to as bad debts or doubtful accounts.
Lenders may also add an amount to cover the cost of credit insurance. This coverage repays the balance of the amount owed if the borrower dies or becomes disabled.
Total Dollar ChargesTo make you aware of the total cost of credit, federal law requires that the lender must tell you the finance charge. The finance charge is the total dollar cost of credit, including interest and all other charges. Either your contract or your charge account statement must state this finance charge.
Compare Credit CostsIf you have to borrow money or buy on credit, be sure to compare the total cost of credit among alternative sources. Check with several lenders and compare the APRs.
If you make a purchase with a credit card, know which card has the lowest APR. If an installment sales contract is required, think about whether an installment loan from a financial institution may be cheaper for you.
When getting a loan, shop around just as carefully as you would for any major purchase. Borrowing money is costly, so make sure that you get the best loan. Some of the things you should check include the annual percentage rate, the amount of the monthly payments, and the finance charge.
Always remember that when you use credit, you are spending future income. If you decide to use credit, the benefits of making the purchase now should outweigh the costs of using credit. Effectively used, credit can help you have more and enjoy more. Misused, credit can result in too much debt, loss of reputation, and even bankruptcy.
Annual Percentage RateThe annual percentage rate (APR) is a disclosure required by law. It states the percentage cost of credit on a yearly basis. All credit agreements, whether for sales credit or loan credit, require disclosure of the APR.
In addition to interest, the APR includes other charges that may be made. Service fees involve the time and money it takes a creditor to investigate your credit history, process your loan or charge account application, and keep records of your payments and balances.
The costs of collecting from those who do not pay their accounts may also be passed on to other borrowers. Uncollectible accounts are frequently referred to as bad debts or doubtful accounts.
Lenders may also add an amount to cover the cost of credit insurance. This coverage repays the balance of the amount owed if the borrower dies or becomes disabled.
Total Dollar ChargesTo make you aware of the total cost of credit, federal law requires that the lender must tell you the finance charge. The finance charge is the total dollar cost of credit, including interest and all other charges. Either your contract or your charge account statement must state this finance charge.
Compare Credit CostsIf you have to borrow money or buy on credit, be sure to compare the total cost of credit among alternative sources. Check with several lenders and compare the APRs.
If you make a purchase with a credit card, know which card has the lowest APR. If an installment sales contract is required, think about whether an installment loan from a financial institution may be cheaper for you.
When getting a loan, shop around just as carefully as you would for any major purchase. Borrowing money is costly, so make sure that you get the best loan. Some of the things you should check include the annual percentage rate, the amount of the monthly payments, and the finance charge.
Always remember that when you use credit, you are spending future income. If you decide to use credit, the benefits of making the purchase now should outweigh the costs of using credit. Effectively used, credit can help you have more and enjoy more. Misused, credit can result in too much debt, loss of reputation, and even bankruptcy.