# How to calculate interest on loan

### As a percent (per year) of the amount borrowed

### Example: Borrow $1,000 from the Bank

Alex wants to borrow $1,000. The local bank says "* 10% Interest* ". So to borrow the $1,000 for 1 year will cost:

**$1,000 × 10% = $100**

## More Than One Year.

### Simple Interest

### Example: Jan borrowed $3,000 for 4 Years at 5% interest rate, how much interest is that?

### Compound Interest

But the bank says "If you paid me everything back after one year, and then I loaned it to you again. I would be loaning you **$1,100 for the second year** !"

And Alex would pay **$110** interest in the second year, not just $100.

**Because Alex is paying 10% on $1,100 not**

**
**

** just $1,000**

This may seem unfair. but imagine YOU were lending the money to Alex. After a year you think *"Alex owes me $1,100 now, and is still using my money, I should get more interest!"*

And so this is the normal way of calculating interest. It is called **compounding** .

With **compounding** we work out the interest for the first period, add it the total, and **then** calculate the interest for the next period, and so on. like this:

It is like paying interest on interest: after a year Alex owed $100 interest, the Bank thinks of that as another loan and charges interest on it, too.

After a few years it can get really large. This is what happens on a 5 Year Loan:

Source: www.mathsisfun.com

Category: Credit

## Similar articles:

How Is a Mortgage Payment Calculated?

Adjustable rate mortgages vs fixed rate - How are adjustable rate mortgages calculated ?