How to Calculate Interest Expense

September 5, 2010 – 6:37 am

I saw a chart in a bill-paying notebook today that had what you would pay per day on a $100 loan with varying interest rates. It had across the top day 1, 2, 3, 4. Then along the side of the chart it had 1/2%, 1% and so on. My “trying to save money” self just couldn’t spend the $2 on the bill organizer for that chart. I’ve surfed online to no avail. Do you have something like that you could show your readers? When we started ‘totaling’ the interest we paid each year for accounting purposes we were stunned.
Autumn in Michigan

Autumn has discovered something that most consumers haven’t learned. A great deal of your hard-earned money each month goes to paying interest on the money that you’ve borrowed.

Rather than put together a chart for Autumn, let’s show her how to assemble her own.

The formula for calculating interest expense isn’t as hard as you might think. We’re going to break it down to make it extremely simple.

The formula is the amount of money borrowed X the interest rate X the length of time that the money is borrowed for.

The amount of money borrowed should be easy to determine. Whether its a mortgage, car loan or credit card balance, your statement should list the balance due (i.e. the amount owed). If it doesn’t you can call the lender and ask them for a current balance. Remember, this is not the amount that you borrowed originally. It’s how much you still owe today.

The interest rate tends to confuse people because it is stated as a percentage. And with percentages come decimal places. But, we’re not going to let a little old decimal point stop us.

An easy way to think of interest rates is to look at the percent sign (%) and see two zeros or two decimal places. So 11% would be .11 and 5% would be .05.

In the real world, most interest rates aren’t exactly even. For instance, your home mortgage might be 5 3/8% or .05375 or a car loan at 11.75% or .1175.

If you still find it confusing, try this trick. Think of 100% as the whole amount. So 100% would translate to 1.00. Which is just what you’d expect it to be.

Finally, let’s consider the length of time the money is borrowed for or how long is it between scheduled payments. Let’s use monthly since that’s the most common.

Almost all interest rates are quoted for a one year period. If we’re making a monthly statement/payment, we’ll need to factor that in. One month is 1/12th of a year or .0833.

Let’s fill out our formula. Suppose that we were borrowing $100 at 14.5% for one month. Filling in our formula we’d get: $100 X .145 X .0833. Or $1.21 in interest due for the month. Using this formula Autumn can calculate any box in the chart.

Another way to get a feel for how much interest is costing you is to look at your monthly statements. Many will tell you exactly how much the interest added to your debt since the last statement. If a statement doesn’t clearly say that just call the lender and ask them. They can tell you to the penny how much interest you’re paying.

Now Amber can make her own chart. Better yet, she can know what each loan is costing her and total them all up to find out how much extra money she’d have each month if it weren’t for her debts. For many people that’s a great motivator to getting them paid off.

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