Interest is defined as the "cost of borrowing money". There are two types of interest, simple and compound. In compound interest the interest amount is added back to the principle periodically so that future interest calculations include paying interest on interest!
Compound Interset 101
Define your terms.
Any interest calculation will require you define several terms. You will need to know the following:
P = principal I = interest rate (as a decimal) N = the number of times the interest is compounded in a year (monthly=12, quartler=4, etc) T = time expressed as the number of years for the calculation A = Answer after T number of years!
Plug your terms in to the follow formula:
step 1) Divide I over N [I/N] step 2) Add 1 [1+ (I/N)] step 3) Multiply by P [ P(1+ (I/N)) ] save this number step 4) multiply N by T [ NxT ] step 5) raise the answer from 3 to the power of the answer to 4 [ans3^ans4]
example:
P = 1,000 I = .1 (10%) N = 4 (quarterly) T = 2
step 1) .1/4 = .025 step 2) 1+.025 = 1.025 step 3) 1,000 x 1.025 = 1025 step 4) 4x2 = 8 step 5) 1,025 ^ 8 = 1,218.40
1,218.40 is the total paid for a $1,000 loan at 10% after two years with quarterly. interest.
