Interest 02

Question 1

1. Interest rates are seldom calculated using the SIMPLE INTEREST RATE formula, but rather using:

Answer 1

The COMPOUND INTEREST formula is used.

Question 2

2. What is COMPOUND INTEREST?

Answer 2

Interest must be paid not only on the PRINCIPAL but also on ANY INTEREST OUTSTANDING AT THAT POINT.

Question 3

3. Example of the difference between COMPOUND INTEREST and SIMPLE INTEREST, with a 1,000 loan at 10% for 2 years (no payment made until the MATURITY DATE):

Answer 3

SIMPLE INTEREST:
Year 1: 1000 x 1 x 10% = 100 interest
Year 2: 1000 x 1 x 10% = 100 interest
TOTAL INTEREST: 200

COMPOUND INTEREST
Year 1: 1,000 x 1 x 10% = 100 interest
Year 2: 1,100 x 1 x 10% = 110 interest
TOTAL INTEREST: 210

Question 4

4. Any loans you take out will, or should, have REGULAR FIXED PAYMENTS which will cover:

Answer 4

at the beginning of the loan, the payment will go primarily to paying off the INTEREST on the loan, with a smaller percentage going to pay off the principal.