Interest Rates

Interest

interested?

Terms You Need to Know

Principal: an amount of money owed by investor and held by a financial institution (normally a bank)

Interest: a rate charged or paid for the use of money

Example of charged:

extra money you have to pay the bank when you take out a loan.

Example of paid:

extra money the bank has to pay you when you leave money in the bank

Annual Percentage Rate (APR): the percentage rate at which interest is calculated annually.

Deposit: the act of establishing, or adding to, existing principal (putting $$$ in the bank)

Balance: the amount of money in an account (how much you have in the bank)

Term: The period of time an investment lasts

Example: the number of years you pay on a car loan.

Simple Interest: interest paid ONLY on the principle amount borrowed or deposited.

Example: you borrow $50 from your friend to buy a concert ticket and they charge you $5 (10% interest) for borrowing the money. You pay them $55 total.

Compound interest:

interest calculated on both the principal you have on a deposit and interest that has accumulated in the past. (The interest + the interest on the interest)

Example: you take out a loan on a car for 5 years and pay not only the initial 5% interest but also an annual interest rate.

Why Should I Care?

The Ugly:

Simple

I = p x r

I = $300 x 5%

I = $300 x .05

I = $15

Total cost = Price + amount of interest

Total cost = $300 + $15

Total cost = $315

Compound

A = P (1 + r)^t

A = $1,800 (1 + 6%)^5

A = $1,800 (1 + 0.06)^5

A = $1,800 (1.06)^5

A = $1,800 (1.338225578)

A= $2,408.81

1. Simple

2.

A = p (1 + r) or I = p x r x t

I = $12,000 X 3% x 5

I = $12, 000 X 0.03 X 5

I = $1,800

3. Total cost = Price + amount of interest

Total cost = $12,000 + $1,800 = $13,800

Mr. Klaameyer's First Vehicle

Mr. Klaameyer's Third Vehicle

Mr. Klaameyer purchases his first vehicle, a '72 (Baby Blue) Chevy Luv. He obtains a loan from a friend for $300. He agrees to pay the loan back by the end of the year at 5% interest.

1. Is this an example of simple or compound interest?

2. How much interest does Mr. Klaameyer end up paying?

3. What is the total cost of the cool baby blue?

For his third vehicle Mr. Klaameyer goes with a stylin' Mazda B2200. He finances this vehicle through a friend who agrees to loan him $12,000 and charge him only 3% simple interest over the next 5 years.

1. Is this an example of simple or compound interest?

2. How much interest will Mr. Klaameyer pay on this vehicle?

3. What much will he repay his friend in total?

The Bad: If you are paying compound interest - you could end up broke!

The Good: If you are earning compound interest - you could end up rich!

Examples

Money grows faster!

Mr. Klaameyer's Second Vehicle

Calculate:

http://www.webmath.com/compinterest.html

Comparing Simple & Compount Interest:

Mr. Klaameyer's Fourth Vehicle

http://appcrawlr.com/ios-apps/best-apps-interest-calculation

http://editorial.autos.msn.com/10-tips-for-regret-free-car-buying

Calculating Simple Interest

http://www.edmunds.com/car-buying/10-steps-to-buying-a-new-car-pg2.html

A = p (1 + r) or I = p x r x t

A = Amount accumulated

p= Principal invested

r = annual interest rate as a percentage

I= interest

t = length of the term (loan, investment)

For his second vehicle Mr. Klaameyer chooses to purchase a 1970's (Orange!) Jeep Wagoneer. This time he borrows $1,800 which he will pay back over the next 5 years at an annual interest rate (APR) of 6%.

1. Is this an example of simple or compound interest?

2. How much does Mr. Klaameyer end of paying in total at the end of 5 years?

Calculating Compound Interest

A = p (1 + r)^t

A = Amount accumulated

p= Principal invested

r = annual interest rate as a percentage

I= interest

t = length of the term (loan, investment)

Einstein is rumored to have declared that compound interest is the most powerful force in the universe!