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 Adjustable-Rate Mortgag...17 Views
Finance allah shmoop What is adjustable rate mortgage or arm
Well here's an arm and here's a leg and that's
What Renting the money to buy a home costs you
Yeah Okay Eight r m stands for adjustable rate mortgage
The rate well that's The interest cost of the money
or the cost of renting that money to buy the
home Well the rate isn't it fixed in this case
like five point seven percent for thirty years Where you
know in advance that your monthly payments going to be
nine hundred forty three bucks a month or whatever it
is that would be a fixed mortgage a fixed number
You can count on it for all three hundred sixty
payments And then the house is all yours So that's
fixed then what's adjustable like yes the interest rate changes
But how does it change Well in a standard arm
there is some global standard on which the rates are
often price like lie bore the london interbank borrowing offering
rate It's one of the key things that price is
the cost of renting money all around the world with
the actual rate of libel or is generally reserved for
banks like super cheap cost of renting money to banks
who are very likely to pay back the money with
no hassle that rate is more or less what banks
pay for running the money along with blue chip customers
in real life The banks then mark up a premium
on top of the rate that they're paying to rent
the money to themselves And then they resell or re
rent that money teo their prized customers So the pricing
of bank my views in renting money to joe six
pack could be something like lie boer plus three percent
or three hundred basis points So if libel or is
it didn't say two and a half percent today the
adjustable rate might be five and a half percent and
all that's great honor given alone It might mean that
for a while you're paying seven hundred twelve dollars a
month for your house payment wonderfully cheap and in fact
banks market these low rates initially to help people be
able to afford tto by that new home and live
of the dream You know the american dream usually with
an arm there's a teaser rate that starts really low
Like at live or live or plus ten basis points
or something like ridiculously cheap for six months or a
year something like that Then it has an incremental set
of step ups in interest costs and venit adjust with
the markets usually upward maybe upward by a lot Remember
there's a reason it's called a teaser rate but then
if we get inflation or a you know just bank
nervousness for there are weird effects from brexit or the
volume of transactions going through london or something weird happens
Well then the liquidity drops and interest rates rise So
now lie board goes up and up and up to
four and a half percent and wealth contractually in your
mortgage paperwork you have to pay live or plus three
hundred basis points no matter what So now that's seven
and a half percent interest on the dough you borrowed
and well we're that toe happen It's likely that your
monthly payment has skyrocketed from seven hundred twelve dollars a
month is something more like twelve hundred dollars a month
or more Can you handle that big of a payment
Well have you done a fixed rate loan at nine
Hundred forty three dollars a month Well you'd still be
paying on that number but you rolled the dice with
an arm and now you owe big bills There go
that arm and a leg thing we warned you about 00:03:26.033 --> [endTime] eh
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