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Math Help - interest rates calculation: how does this work out?

  1. #1
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    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??

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  2. #2
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    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.
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  3. #3
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    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.
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