Interest rate calculation

The majority of loans are increased by interest. Calculating your interest rate will allow you to know the cost of your credit. Learn more

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How to calculate your interest rate

Realizing a loan, whether it is a consumer loan or a mortgage loan, is an easy thing today. However, although many lenders advertise free loans, it is rare that this service is a free service. In fact, by making a loan, the consumer will have the obligation to discharge his debt plus a sum of money otherwise called interest, calculated from a rate. Although this rate is clearly displayed on the offers, it is possible to notice that the latter varies, from one loan to another, from one establishment to another. How then to calculate the interest rate of a loan? how do you know if the calculation of the interest rate will be the same? how to choose your loan based on an interest rate calculation?

Calculating the interest rate: but what is an interest rate?

As we have just said, the interest on a loan is the sum that the borrower must pay to the lender in addition to the principal due. Interest is therefore the part of the remuneration of the lending institution. The interest rate is nothing other than the percentage of this annual income compared to the amount borrowed. Thus when calculating the interest rate, we seek to calculate the cost of a loan for the borrower but also the part of the lender's remuneration. For the borrower, therefore, this is the price to pay to obtain the money. For the lender who sets the rate at the signing of the contract, it is also a security in the event of non-return of the borrowed sum. Interest is therefore used to make up for the shortfall. To set the amount of interest, two rates are taken into consideration: on the one hand, a reference rate set by the Central Bank. This rate corresponds to the minimum rate that the credit rate can take and on the other hand the usury rate, namely the maximum legally authorized rate. The credit rate cannot exceed the fixed usury rate. These two rates are set quarterly.

Nature of the rate and calculation of the interest rate

When calculating the interest rate, the nature of the interest rate will be crucial in calculating the interest rate. Indeed, whether it is fixed, variable or capped, the nature of the rate will lead to modifications in the calculation of the interest rate.

Generally lending institutions use fixed interest rates, ie rates that do not vary during the period of amortization. The monthly payments will therefore be identical throughout the reimbursement, which represents a safe solution for the individual.

In the case of a variable interest rate, it is revalued according to the reference rate to which it is indexed. For this, banks use the Euribor, the US dollar Interbank Offered Rate. This rate is reassessed several times a year, namely every 3.6 or 12 months. The Euribor is an index that fixes the price of the money that banks lend to each other.

Finally, the lending institutions have implemented for a few years rates called capped rates or adjustable rates. These rates are certainly variable rates but they are limited. Indeed, they vary between a ceiling and a floor. This range of variability allows the consumer to always be able to repay his debt unlike a simple variable rate where inflation can lead to default in repayment.

The use of a variable rate in the calculation of the interest rate can therefore be very complicated because regardless of the party concerned (borrower or lender), no one can predict the evolution of the course of interest rates in the time. The increase or even the decrease to the reference value, all of its variations therefore cause great insecurity for the consumer. As for capped rates, although framed by an interval, the variation in the calculation of the interest rate can put the consumer at fault. It is therefore generally not recommended for individuals to subscribe to loans whose interest rate calculation involves one of these two types of rate. In addition, fixed rates (especially fixed rates for mortgage loans) are relatively low in United States at the moment, it is very rare that variable rates are used by financial institutions.

Calculation of the interest rate: define the total cost of a loan.

When we speak of the cost of credit, it is not uncommon to cross the term TEG, the Global Effective Rate or even APR, the Annual Global Effective Rate. When calculating the interest rate, it is this rate that will be used to determine the borrower's annual remuneration. Defined upstream when the credit contract is signed, this rate, as we said previously, must therefore be within a defined interval between the reference rate and the usury rate, i.e. the maximum rate set by the Bank from United States. The table below groups together the different rates in effect during the 3rd semester of 2016 for the main loans. You can find the rates in effect at the time of your subscription on the Bank of United States website.

Table of average staffing rates (TEG) and wear rates in effect in the 3rd half of 2016.

Categories

Average Effective Rate (TEG)

Wear rate

(3rd quarter 2016)

(4th quarter 2016)

Fixed rate mortgage loans

2.71%

3.61%

Variable rate mortgage loans

2.34%

3.12%

Bridge loans

2.78%

3.71%

Consumer loans of an amount less than or equal to 3,000 US dollars

15.01%

20.01%

Consumer loans in an amount greater than 3,000 US dollars and less than or equal to 6,000 US dollars

9.74%

12.99%

Consumer loans over US $ 6,000

5.21%

6.95%

So when we want to calculate the interest rate, several criteria will be taken into account. The first will obviously be the borrowed capital. In calculating the interest rate, the duration of the loan will also be taken into account as well as the APR. If we take the example of a loan of 3000 US dollars over a period of 3 years with an APR of 15.01%, the amount of interest in fine will be:

Calculation of the interest rate = (principal X duration of credit X APR) / 100 = (3000 X 3 X 5.01) / 100 = 1350.9 US dollars.

Here we have chosen to use the annual duration but it is possible to calculate the interest rate using the number of months or the number of days and divide by 1200 to calculate the interest rate which will give in the previous example:

Interest rate calculation = (3000 X 36 X 15.01) / 1200 = 1350.9 US dollars (3 years = 36 months)

or, calculation of the interest rate = (3000 X 1095 X 15.01) / 36,500 = 1350.9 US dollars (3 years = 1095 days)

However, the principal owed will decrease over time and with repayments. Interest will therefore be revised downwards with each new monthly payment. In order to obtain the correct calculation of the interest rate, it will therefore be necessary for you to take into account the outstanding capital and not the initial capital. So if in general we can calculate the interest rate in the previous way, you will have to divide the annual amount by 12 to get the monthly interest amount. This amount will then correspond to the first rent of your interest. To obtain the amount of interest during the second month, you will have to recalculate the amount of interest by taking into account the capital remaining due in the second month. So if we take the previous example of a loan of 3000 euros over a period of 3 years with an interest rate of 15.01%, the amount of interest for the first month will be:

3000 x (15.1% / 12) = 37.75 US dollars.

The amount of interest for the first month will therefore be 37.75 US dollars.

Then to calculate the amount of interest in the following months, you will need to use the amount of principal due in the calculation of the interest rate. For this, you will have to withdraw at the initial amount, the amount of the first monthly payment and perform the same calculation. This calculation is quite tedious but there are a large number of websites equipped with simulators allowing you to calculate the interest rate as well as the calculation of monthly payments, loan costs among others.

In short…

As we have seen, when we take out a loan it is important to be interested in the calculation of the interest rate. The interest represents the percentage of the capital that will be paid back to the lending institution. The interests are on the one hand a security in the event of non-payment of the credit by the borrower but also his source of income. Calculating the interest rate is tedious and it will be better for you to be well informed before taking out a loan. Remember to compare the different interest rate calculations in order to get the best deal for your credit. Check the rates in effect when you want to take out a loan. In general, when calculating the interest rate, you will need to check that the interest rate is not higher than the limit set by the Bank of United States. Finally, don't forget to take the nature of your interest rate into account when calculating the interest rate. A fixed APR will always be more advantageous for you than a variable APR. Also find out about capped APRs, a good alternative when fixed APR prices are not the best.

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