Other than giving us discounts at Ross, what are percents good for?
Well, we don't always have to spend money to save it. Instead, we can make an investment or tuck it away into a savings account. Banks and investors actually pay us to do this by offering interest rates, usually given as—you guessed it—percents.
The amount of interest we earn, I, depends on four factors:
- the principal, P
- the interest rate, r
- the time, t
- how often the interest is compounded
The principal is the original amount of money you put into the loot. Whether you deposit $30 into a savings account or invest $500,000 in your cousin's startup company, that's the principal. Just to be clear, we aren't talking about your principal, Mrs. Lipschitz.
The interest rate is the percent of the principal that you earn. The higher the interest rate, the more money you'll earn. (Note: this is the opposite when taking out loans. Loans with high interest rates mean you'll have to pay more money back. It's a good lesson in context.)
The time we're talking about is the amount of time you let your investment simmer. The more time you leave your savings alone, the more you'll have saved up. (On the flip-side, the longer you leave your debts and loans unpaid, the more you'll owe in the long run.)
Compounding interest means adding the money you've earned from interest to the principal amount. It's a good thing for savings (but a bad thing for loans) because the interest rate will be applied to a larger balance. Basically, it means you'll earn (or owe) more money...faster.
We won't get into compound interest here, because that can get real complicated real fast. Instead, we'll talk about simple interest, or the amount of interest you can earn from the principal alone. That's right, Mrs. Lipschitz. Put down those knitting needles and pay up.
We can use a simple formula to calculate I: the interest you earn. If we know the principal P, the interest rate r, and the time t, all we have to do is multiply these three values together. As a formula, it looks like this:
I = Prt
When plugging values into the equation, it's a good idea to check for a few things. Our interest rate r should be in decimal form. Since percents are out of 100, it's easy to convert them into decimals. The interest rate and time need to have the same units. If you get 4% interest every month, you'll want to multiply that by the principal and the number of months you've had your investment, even if it's been 30 years.
Don't stress about calculating simple interest. After all, there's a reason it's called simple interest. And despite how much interest you earn on your principal, it's bound to be more interesting than your principal. Come on, Mrs. Lipschitz...look alive.
Mrs. Lipschitz?
Related or Semi-related Video
Finance: What is Interest Only Mortgage?17 Views
Finance allah shmoop what is an interest only mortgage Well
simply put it's when you only pay the rent on
the dough you borrowed you don't pay down the principal
you owe like if you have a three hundred thousand
dollars mortgage at six percent interest you're paying eighteen grand
a year to rent that money in six percent times
three hundred rands eighteen grand a year But the principal
you borrowed is likely due in thirty years So in
theory anyway if it were a normal mortgage you'd want
to pay down the principal little bit a month as
you go along like averaging ten grand a year in
principle pay down over thirty years That's times ten grand
right three hundred grand their total owning your home at
the end yeah yeah priceless that's what holmes work So
why would you want an interest only mortgage Well for
one thing the monthly payments or less so maybe you
could afford morehouse If on a thirty year three hundred
thousand dollar loan at six percent you're paying interest only
while you're writing a check each month for eighteen thousand
divided by twelve or fifteen hundred bucks maybe that's all
You can afford well the extra five hundred bucks arm
or you'd right toe pay down your principles Just not
something you can really do right now Maybe after three
years of scrimping and saving well you'll be able to
start paying down that principal reducing risk and making life
easier all the way around But right now you can't
afford it so the only thing you can do is
do the interest only dance Well the other reason you
might want an interest only mortgages that interest costs are
tax deductible Principal pay down costs are not so if
in a given mortgage payment of say eighteen hundred bucks
a month where three hundred of it is principal pay
down and fifteen hundred of it is interest well on
ly the fifteen hundred is tax deductible That three hundred
of pay down is not And if you're a forty
percent taxpayer the government is essentially picking up the tax
savings on the fifteen hundred times a forty percent at
six hundred dollars in interest You're paying such that they
quote feel unquote like the fifteen hundred is really only
about nine hundred a month in cost to you the
three hundred bucks and principal paydown feels like a full
three hundred dollars So some people seeking tio optimize their
tax deductions live in the world of interest only mortgages
and let the government for a change You know work 00:02:26.24 --> [endTime] for them How's that feel same all Take it
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