How to Calculate Compound Interest - Calculating Compound Interest

The compound interest is calculated on a principal sum, which is a sum of the basic principal amount and the initial interest on that amount. In other words, the interest is compounded to the original sum. If a loan on an amount of $100 is to be repaid at 2% interest at the end of 1 month, the total amount to be returned would be $102. If the interest on the sum is compound one, to be collected after a period of 2 months, the principal on which the total amount due to be paid is $102. In this case, the earlier interest of 2% is said to be 'compounded' to the principal amount. The total amount due, at the end of two months, would be $104.04, as the new interest would be $2.04.

Compound Interest: An Overview

Compound interest calculation can be made as per the norms laid down by the condition of the respective agency or institution. The dealings vary for every different body that is involved in the project. For example, if you want to borrow a loan from a bank, then the most important factor considered is the loan interest that has to be added with the borrowed amount. In fact, compound interest on an amount happens to be the most useful of all the data available on that particular transaction.

Compound interest calculators are available on many websites and it can also be calculated manually, by applying mathematical formula. Loan calculators, especially employ a wide application of compound interest calculations. It is very important to understand the functioning of compound interest and relevant financial terms, in order to get the best finance deal. The rate of interest and the period for which it is valid, are the two main areas of concern while considering a standard sum. Compound interest is the best measure to consider and compare different options and feasibility of a given deal, in accordance with your needs. Usually, a standard practice is to consider the rate on an annual term referred to as the effective rate of interest, annual percentage rate or simply annual rate. It can also be converted to a standard base to compare the rates of different annual rates of compound interest.

How to Calculate Compound Interest

The mathematical formula for the calculation of the total amount (A), based on a certain rate of compound interest calculated R for a time period (n) is

A = P x (1+R/100)ⁿ

This equation gives the value of the amount accrued at a particular rate of interest on a certain principal value (P) over a fixed duration of time. The formula for calculation of compound interest follows logically, which is given as below.

Interest = A – P

Thus, the interest amount in this case, itself serves as a principal to garner furthermore interest. There are various derivations based on the above formula, which bring out the suitability and the application of compound interest in versatile situations. There are situations when compound interest is not calculated on a yearly basis.

In case of half yearly periods, the time period in calculation is doubles and the rate becomes half.

A = P x (1+R/200)^{2 x n}

Similarly, for a quarterly calculation the time is increased 4 times and the rate is decreased by one-fourth the actual figure and the same formula can be modified accordingly. The formula for interest in each case remains, the same which is Interest = A - P

Thus, the compound rate of interest is calculated.