How do you calculate how much interest you will pay for a loan?

Answer 1

The calculation is truly dependent on the type of loan, the compounding period and the duration of the loan.

Basic (simple) interest is calculated as follows:

I = P * r * t

where:

I = interest owed

P = principal balance (original amount borrowed)

r = annual interest rate

t = loan duration in years

So, say you are borrowing $10,000 for one year at 12% interest. Plugging in the numbers:

P = 10,000; r = 12% = 0.12; t = 1

I = 10,000 * 0.12 * 1 = 1,200

So, the simple interest for a year is $1,200.

The above steps indicate the process of calculating the interest. But if you wish to decide about the rate of interest you are ready to pay for the loan, it is dependant upon the cash flow that will occur during the same period by which you pay interest. Please remember cash flow is different from profit. However if you pay a major portion of your profit ( income ) towards interest, then it implies that your are working for the lender than for yourself.