What Is the Rule of 72 for a Business Loan?

The Rule of 72 is a rule-of-thumb estimate for calculating the time value of money. It can be an effective means of avoiding the need for a calculator or complex mathematical formula to compute such an estimate. The rule can be applied to either a loan or an investment transaction.

Function

The Rule of 72 is used to answer either of the following two questions: (1) assuming a specific average annual interest rate, what will be the initial money balance (for either a loan or an investment) over a specific period of time? or (2) assuming a specific money balance (for either a loan or an investment) at the end of a specific period of time, what will be the average annual interest needed to reach that balance?

The Rule of 72

The Rule of 72, which is based on a mathematical equation, can be described as follows: at a 7.2 percent annual interest rate, an investment or loan balance will double in 10 years. Conversely, at a 10 percent annual interest rate, an investment or loan balance will double in 7.2 years.

Examples

For example, assume you want to start a business but need to borrow money in order to do so. If you borrow $50,000 at a 7.2 percent annual interest rate and the total repayment, including principal and interest, is due in 10 years, what will be your payment amount? Based on the Rule of 72, it will be $100,000. Similarly, if you invested $50,000 with a 7.2 percent annual rate of return, the value of your investment at the end of 10 years is $100,000.

Complex Examples

What if your interest/rate of return or your loan/investment time frame involves numbers other than 7.2 or 10? The answers can be estimated using the following simple equations.

The estimated number of years it would take for an initial loan balance/investment to double is equal to 72 divided by the interest rate. For example, it would take 4.8 years for the initial balance to double at a 15 percent interest rate (72 / 15 = 4.8).

The estimated interest rate resulting from a doubling of the initial loan balance/investment capital in x years is equal to 72 divided by x. For example, an interest rate of 20 percent would double the initial balance in 3.6 years (72 / 20 = 3.6).

Bottom Line

The Rule of 72 makes it relatively easy to estimate loan costs or investment yields. Anything that makes money decisions easier is a definite plus.

References

• AccountingSuite101: Interest Income, Expense and the Rule of 72