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

1. Interest rates can often vary over a loan period and affect the loan. 
2. Always read the terms and conditions carefully before applying
3. Monitor your interest rates periodically 
4. 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