Interest Calculator

Understanding Interest: A Key Financial Concept

Interest is the cost of borrowing money, paid by the borrower to the lender, either as a percentage of the loan or a fixed amount. It is a fundamental principle behind most financial transactions worldwide.

There are two primary types of interest: simple interest and compound interest.

Simple Interest

Simple interest is calculated only on the original loan amount (principal). For example, if Derek borrows $100 from the bank at an annual interest rate of 10%, the interest for one year would be:100×10%=10100 \times 10\% = 10100×10%=10

After one year, Derek owes the bank:100+10=110100 + 10 = 110100+10=110

If he extends the loan to two years, the interest is charged separately for each year:100+10(Year1)+10(Year2)=120100 + 10 (Year 1) + 10 (Year 2) = 120100+10(Year1)+10(Year2)=120

The formula for simple interest is:Interest=Principal×Rate×Time\text{Interest} = \text{Principal} \times \text{Rate} \times \text{Time}Interest=Principal×Rate×Time

Simple interest is rarely used in financial products, as most interest structures involve compounding.

Compound Interest

Compound interest differs from simple interest because interest is applied not only to the principal but also to previously earned interest. Using the same example, after the first year, Derek’s loan balance grows to $110. In the second year, interest is calculated on this new amount:110×10%=11110 \times 10\% = 11110×10%=11

At the end of two years, Derek owes:110+11=121110 + 11 = 121110+11=121

This extra dollar difference compared to simple interest ($120) occurs because interest accumulates on previously earned interest.

The frequency of compounding (daily, monthly, annually) affects the total amount of interest earned or paid. The more frequent the compounding, the higher the total interest.

The Rule of 72

A quick way to estimate how long it takes for an investment to double is the Rule of 72:Years to double=72Interest Rate(%)\text{Years to double} = \frac{72}{\text{Interest Rate} (\%)}Years to double=Interest Rate(%)72​

For example, at an 8% interest rate:728=9\frac{72}{8} = 9872​=9

So, it takes about 9 years for an investment to double at 8% interest. This rule is most accurate for interest rates between 6% and 10%.

Fixed vs. Floating Interest Rates

Interest rates can be fixed (unchanging over the loan period) or floating (adjusting based on market benchmarks like the U.S. Federal Reserve rate or LIBOR). Floating rates fluctuate, making them riskier but potentially more beneficial in a declining interest rate environment.

Contributions and Interest Growth

If regular deposits are made into an account earning interest, whether at the beginning or end of the compounding period affects the final amount. Contributions made at the beginning of a period accrue more interest over time.

Impact of Taxes and Inflation

Interest income on bonds, savings accounts, and CDs may be subject to taxes, reducing overall returns. Additionally, inflation—the gradual increase in prices—lowers the real value of money.

For example, if Derek invests $100 at 6% annual interest for 20 years, his balance grows to:100×(1+6%)20=320.71100 \times (1 + 6\%)^{20} = 320.71100×(1+6%)20=320.71

However, with a 25% tax rate, his actual return drops to $239.78.

Inflation further erodes purchasing power. The U.S. historical inflation rate averages around 3%, meaning an investor must earn at least 4% after taxes to preserve the real value of money.

Final Thoughts

Understanding how interest works—especially the power of compounding—is essential for making informed financial decisions. Whether saving, investing, or borrowing, considering factors like compounding frequency, taxes, and inflation can help maximize financial growth and minimize costs.