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Interest Rate
What Does it Mean?
Interest rate is the percentage amount of charge applied to the principal amount by the lender, which means that the total money borrowed includes the principal + interest percentage of the principal. The lender can be banks or any financial institution.
Bank charges can be either fixed or variable throughout the tenure. It depends on the type of loan, such as:
- Mortgage loans
- Credit card bills
- Educational loans
Simple Interest
Simple Interest is calculated on the principal amount at a fixed rate. Here’s a quick synopsis of what it means:
- You can quickly compute it by multiplying the principal by the tenure and interest rate
- In this case, you don’t have to pay interest on interest
Consider the following example:
- Principal amount = ₹20,000
- Tenure = 5 years
- Interest rate = 10% p.a.
The following table shows how your simple interest will be computed for different tenures.
| Principal Amount | Tenure | Interest | Total |
|---|---|---|---|
| ₹20,000 | 1st year | ₹2,000 | ₹22,000 |
| ₹20,000 | 2nd year | ₹2,000 | ₹24,000 |
| ₹20,000 | 3rd year | ₹2,000 | ₹26,000 |
| ₹20,000 | 4th year | ₹2,000 | ₹28,000 |
| ₹20,000 | 5th year | ₹2,000 | ₹30,000 |
Compound Interest
The term refers to the interest calculated not only on the principal amount but also on any interest accumulated from previous compounding periods. Thus, it is also called ‘interest on interest’ compounding.
Say you opt for a loan with the following criteria:
- Amount borrowed = ₹20,000
- Tenure = 5 years at a 10% p.a.
- Interest rate = 10% p.a.
Here’s how your compounded interest will be calculated:
| Principal Amount | Tenure | Interest earned | Total |
|---|---|---|---|
| ₹20,000 | 1st year | ₹2,000 | ₹22,000 |
| ₹22,000 | 2nd year | ₹4,200 | ₹24,200 |
| ₹24,200 | 3rd year | ₹6,620 | ₹26,620 |
| ₹26,620 | 4th year | ₹9,282 | ₹29,282 |
| ₹29,282 | 5th year | ₹12,210.20 | ₹32,210.20 |
How to Calculate Interest
Here is the formula to calculate the simple interest:
Interest = Principal * Interest Rate * Tenure
The formula to calculate compound interest is:
Interest = Principal (1+ i) n – Principal
Where,
i = annual interest rate
n = tenure
Points to Remember
- Interest rates can often vary over a loan period and affect the loan.
- Always read the terms and conditions carefully before applying
- Monitor your interest rates periodically
- Regularity in repayment majorly affects one’s credit score, so you must repay your loans on time.
FAQs on Interest Rate
What is the interest rate with an example?
To understand what is an interest rate, let’s take an example where:
- Principal amount = ₹50,000
- Interest rate = 10% p.a.
- Tenure = 1 year
Throughout the tenure, you will be paying a total amount of ₹55,000 in EMIs. This additional ₹5,000 is the interest the lender charges for extending their services.
How to calculate the interest rate?
You must know whether the lender charges compound or simple interest before calculating the interest rate. After that, you can use the formula accordingly to estimate the interest rates. Alternatively, you can use online calculators to compute the applicable interest levied on your loans.
What is the interest rate formula?
Here are the formulas to calculate the interest:
- Simple interest rate = (Interest Earned × 100) / (Principal × Time)
- Compound interest rate = Principal (1+ Annual Interest Rate) Tenure – Principal