How to Calculate Compound Interest

When someone takes a loan from a bank or other lending institution, they often face difficulty in understanding the concept of calculating interest and when it comes to estimating the compound interest, the task becomes just more difficult. Interest is of two types, simple and compound. If you have availed financing from somewhere and you want to make sure whether your interest is being calculated properly or you are not overcharge, with a little help, you can easily calculate your compound interest.

Instructions

  • 1

    Understanding of terms

    It is of pivotal importance that an individual should have the sound knowledge of all the terms involved in lending and borrowing. For instance, principal amount is the figure which an individual actually needs to borrow from someone for a particular reason. On the other hand, interest rate is the amount that is charged by a lender to give the principal amount to the borrower. The interest rate is specified in percentages and represents the yearly rate of interest over a particular principal amount.

  • 2

    Know the difference between simple and compound interest

    In order to calculate your compound interest, it is of utmost importance that you understand the difference between these two terms otherwise there is a greater chance that you will mix up both of these terms and miscalculate your interest. A simple interest is where an individual pays interest only on his principal amount while in compound interest, the person pays interest not only on his principal amount but also on the interest paid in the past. In compound interest, the lender enjoys more and more money while the borrower has to suffer the extra cost of financing.

  • 3

    Learn the formula

    There is a simple formula for calculating the compound interest, you must learn it. The formula is: A = P(1 + i)^t.

    Here, A is the amount that you have to pay in total which comprises of the principal and the compound interest. P is the principal amount, i is the interest rate levied on the principal amount by the lender and t is the term or time for which the amount is lend to a particular borrower.

  • 4

    Put in values

    Now you should put in values in the formula to calculate your compound interest. For example, if you have taken $2000 at the rate of 10 percent annually for 2 years. Then,

    A = $2000(1 + 0.10)^2 = $2000 * (1.10)^2 = $2000 * 1.21 = $2420

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