Interest Rate

There are several different types of interest. The most common type of interest is simple interest. Simple interest is determined by multiplying the principal by the interest rate (per period) by the number of time periods. Simple interest does not take compounding into the account. To calculate simple interest you would add up all the interest paid in a period and divide that number by the principal amount at the start of the period. There are three common problems with simple interest.

A common problem is that when using the time period to calculate the interest can be inaccurate as time period can be different. Another common problem is that the time value of money can be incorrect. The final of the three most common problems with simple interest is what happens if the interest that is due is not paid. Compound interest is a way to calculate interest in a way that the three common problems with simple interest do not affect the result.

Interest is determined at a yearly rate and is compounded yearly. Real interest attempts to measure interest in units of stable purchasing power. It is calculated by subtracting inflation from the nominal interest rate. Cumulative interest does not use the per year convention and assumes compounding interest at every payment date. It is usually used to compare two long term opportunities, because the difference in the interest rates is magnified by time, it easier to show which opportunity would make or cost more money.

Contributing National Payday Staff Writer

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