Loans and Investment Concepts

Compound Interest

This type of interest on a loan or deposit is calculated based on both the initial principal (initial amount of money prior to investment) and the accumulated interest from previous periods.

The formula to calculate compound interest is as follows:

A = the final amount

i = the interest rate per compounding period (annual interest rate / # of compounding periods per year)

P = the principal/initial amount

n = the number of compounding periods (# of months, years, etc.)

Example:

Let's say Will has $60,000 and he chooses to invest it at 2%, compounded monthly, for 4 years. To find the amount:

A = 60000(1 + (0.02/12 months)^(4 years x 12 months)

A = $64,992.90

Simple Interest

This type of interest on a loan or deposit is solely calculated based on the initial principal.

The formulas to calculate simple interest are as follows:

For total amount of interest earned

For total balance

I = the total interest

P = the principal/inital amount

r = the interest rate

t = the # of interest periods

A = the final amount

Example:

Let's say Maria is running a landscaping business and needs to borrow some money. She borrows $1000 from a bank at 9% simple interest and wants to pay it off in two years in a lump sum. To find the total interest:

I = (1000)(0.09)(2)

I = $180

And to calculate the total balance after 2 years

A = 1000 + 180

A = $1180

Common Applications of Interest

Mortgage

A loan, typically provided by a bank, for a property

Savings Account

A bank account, typically used for retirement income or emergencies, where one deposits non-essential income to save for later

Investments

Investing in index funds, buying a specific amount of shares in a company through stock picking, or investing in real estate with the expectation their values will rise are all different, and common ways some people generate passive income on top of their regular jobs through investments.

Bonds

Loans can be provided for the government from private citizens or institutions. People can buy bonds at a central bank-specified interest rate that fluctuates over time.