# interest rates calculation: how does this work out?

• Aug 18th 2012, 03:03 AM
interest rates calculation: how does this work out?
Hi

If you take a loan of \$100 at 5% compounded interest per year, and pay for it over 12 months, you'd have paid the following:

Monthly Payments - \$8.56
Total Payments - \$102.73

That is clearly less than 5% interest. In fact, intuitively, you'd have expected to pay > 5% in effective interest rate. Yet you don't even pay 5% in interest!

How does this work out??

• Aug 18th 2012, 05:15 AM
skeeter
Re: interest rates calculation: how does this work out?
if you took out the loan and paid nothing till the end of the year, then you pay \$105 at the end of the year.

by making regular monthly payments you decrease the principal owed, hence the interest is calculated on a regularly decreasing amount.
• Aug 18th 2012, 05:07 PM
Wilmer
Re: interest rates calculation: how does this work out?
This is what the "loan account" looks like:
Code:

```MN    PAYMENT  INTEREST  BALANCE 00                        100.00 01      -8.56    .42      91.86 02      -8.56    .38      83.68 .... 11      -8.56    .07        8.52 12      -8.56    .04        .00```
Add up the 12 "interest" amounts (get the other 8 yourself!) and you'll get 2.73.