Interest refers to fees charged for the right to use money that belongs to someone else. Banks often pay interest to customers on deposit accounts, while customers pay interest to lenders when they take out loans. Interest can be calculated as simple interest or compound interest. Compound interest takes into consideration the amount of money that will be earned on interest that gets added to the account. To calculate interest, you need to know the amount in the account, the interest rate on the account, how long the money remains in the account and how often the interest will be compounded.
Simple Interest
Divide the annual interest rate by 100 to convert it to a decimal. For example, if the annual interest rate is 8 percent, you would divide 8 by 100 to get 0.08.
Divide the annual interest rate, expressed as a decimal, by the number of times per year interest compounds to calculate the periodic interest rate. Continuing the example, if the account compounds interest quarterly, you would divide 0.08 by 4 to get 0.02.
Multiply the periodic interest rate by the balance of the account. For example, if the account has a balance of $500, you would multiply $500 by 0.02 to find the interest would be $10.
Multiply the interest per period by the number of periods the money will remain in the account. Finishing the example, if you leave the money in the account for five quarters, you would multiply $10 by 5 to find the total interest would be $50.
Compound Interest
Divide the annual interest rate by 100 to convert it to a decimal. For example, if the annual interest rate equals 8 percent, divide 8 by 100 to get 0.08.
Divide the annual interest rate expressed as a decimal by the number of times per year interest compounds to calculate the periodic interest rate. Continuing the example, if the account compounds interest quarterly, you would divide 0.08 by 4 to get 0.02.
Add 1 to the periodic interest rate expressed as a decimal. In this example, you would add 1 to 0.02 to get 1.02.
Raise that result to the Nth power, where N equals the number of periods that the money will remain in the account. In this example, if you were leaving the money in the account for five quarters, you would raise 1.02 to the fifth power to get 1.104080803.
Subtract 1 from that result to calculate the total interest rate. In this example, you would subtract 1 from 1.104080803 to get 0.104080803.
Multiply the total interest rate by the balance of the account to find the total interest. Finishing the example, if you had $500 in the account, you would multiply $500 by 0.104080803 to find the total interest would be $52.04.
