13Nice - How Do I Calculate Finance Charges?
Having some knowledge of
how to calculate finance charges is always a good thing. Most lenders, as you
know, will do this for you, but it can helpful to be able to check the math
yourself. It is important, however, to understand that what is presented here
is a basic procedure for calculating finance charges and your lender may be
using a more complicated method. There may also be other issues attached with
your loan which may affect the charges.
The first thing to
understand is that there are two basic parts to a loan. The first issue is
called the principal. This is the amount of money that is borrowed. The lender
wants to make a profit for his services (lending you the money) and this is
called interest. There are many types of interest from simple to variable. This
article will examine simple interest calculations.
In simple interest deals,
the amount of the interest (expressed as a percentage) does not change over the
life of the loan. This is often called flat rate or fixed interest.
The simple interest
formula is as follows:
Interest = Principal ×
Rate × Time
Interest is the total
amount of interest paid.
Principal is the amount
lent or borrowed.
Rate is the percentage of
the principal charged as interest each year.
To do your math, the rate
must be expressed as a decimal, so percentages must be divided by 100. For
example, if the rate is 18%, then use 18/100 or 0.18 in the formula.
Time is the time in years
of the loan.
The simple interest
formula is often abbreviated:
I = P R T
Simple interest math
problems can be used for borrowing or for lending. The same formulas are used
in both cases.
When money is borrowed,
the total amount to be paid back equals the principal borrowed plus the
interest charge:
Total repayments =
principal + interest
Usually the money is paid
back in regular installments, either monthly or weekly. To calculate the
regular payment amount, you divide the total amount to be repaid by the number
of months (or weeks) of the loan.
To convert the loan
period, 'T', from years to months, you multiply it by 12. To convert 'T' two
weeks, you multiply by 52, since there are 52 weeks in a year.
Here is an example problem
to illustrate how this works.
Example:
A single mother purchases
a used car by obtaining a simple interest loan. The car costs $1500, and the
interest rate that she is being charged on the loan is 12%. The car loan is to
be paid back in weekly installments over a period of 2 years. Here is how you
answer these questions:
1. What is the amount of
interest paid over the 2 years?
2. What is the total
amount to be paid back?
3. What is the weekly
payment amount?
You were given: principal:
'P' = $1500, interest rate: 'R' = 12% = 0.12, repayment time: 'T' = 2 years.
Step 1: Find the amount of
interest paid.
Interest: 'I' = PRT
= 1500 × 0.12 × 2
= $360
Step 2: Find the total
amount to be paid back.
Total repayments =
principal + interest
= $1500 + $360
= $1860
Step 3: Calculate the
weekly payment amount.
Weekly payment amount =
total repayments divided by loan period, T, in weeks. In this case, $1860
divided by 104 weeks equals $17.88 per week.
Calculating simple finance
charges is easy once you have done some practice with the formulas.
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