How to Calculate Compounding Interest

You may have made a major purchase or investment and either paid or received compound interest. Most people, however, don't know how the bank figures how much to charge or pay them every month. There are calculators available which will figure compound interest for you, but when making a major financial purchase or investment, you may want to know exactly where your money is going or coming from.

Instructions

1. Learn what compound interest is. Compound interest is interest paid on the principal loan or investment sum combined with interest on any outstanding interest incurred.

2. Gather some basic facts about the loan or investment you want to calculate compound interest for. You will need to know the principle amount you started with, the yearly rate of interest paid and the number of years you want to calculate the interest.

3. Use the formula M = P(1+i)^n where "M" equals the final result, "P" is the principle, "i" is the yearly interest rate and "n" is the number of years you want to figure the interest for.

4. Start by working the part of the formula in parenthesis. Add 1 to the yearly interest rate. Then, take that number to the power equal to the number of years you want to calculate the interest for. The power is calculated by taking the number times itself. For example, if you are figuring the interest over a 5 year period, you take the number times itself five times.

5. Take the result of the number in parenthesis and multiply it by the principle. The result is how much money will result from compound interest over the period of years you specified.

6. Try an example. To figure out how much money you will have in 5 years if you invest $10,000 in a savings account that pays 3 percent interest, the formula would be M= 10,000(1 + .03)^5. 1 + .03 is 1.03 and 1.03 times itself 5 times is 1.1592. 10,000 times 1.1592 equals 11,592. So, after 5 years at 3 percent interest, $10,000 becomes $11,592.

7. Check your work with the compound interest calculator at Webmath.com. Click on "Math for Everyone" and choose "Compound Interest" under "Personal Finance."

Resources

• Calculate compound interest at Webmath.