How to Calculate Interest Income

Simple interest is quite easy to calculate using a calculator or an adding machine. If you need to calculate compounded interest using a calculator, there will be many calculations. To calculate compounded interest, you should use a spreadsheet or an online interest calculator to simplify the process. However, we can look at how to manually calculate interest income for both simple and compound interest. Knowing how to calculate interest can help you decide how to invest your money. Do you receive bank card temporary offers at a fixed rate with an initial fee? Knowing how to calculate interest can help you decide if your bank card is offering you a good deal or not.

Things You'll Need

• Computer with spreadsheet software
• Calculator
• Paper
• Pencil
• Interest rate to be paid
• Type of interest
• Interest payout periods
• Amount of money invested

Instructions

1. Decide on the amount that you will be investing in an interest-bearing account. Check on interest rates being offered for various types of accounts. For example, can the money be tied up for six months or longer? If so, consider CDs (certificates of deposit) because they pay higher rates than regular savings or checking.

2. Ask the financial institution about fees before depositing money. An example of a fee that can deplete your account is a fee for having an account drop below a certain balance. Some financial institutions charge for exceeding a number of withdrawals every month. These items all need to be taken into consideration when calculating interest income because they will reduce the percentage.

3. Multiply the principal amount (the amount you wish to deposit) times the interest rate times the length of the investment for a simple interest calculation. Simple interest = (principal x rate x time) = SI [simple Interest] = (P---R---T). Remember to change your interest percentage into a decimal. For example, 5 percent = .05, 12 percent = .12 . Remember this little rhyme, 7 percent=7 cents, that is, 7 percent=.07.

4. Use sample numbers to practice. Principal to invest is $1,000. The current interest rate for a one-year CD is 4 percent. Therefore SI = ($1,000 x .04 x 1), SI = $40. Remember that the period of interest calculation is always based on one year. Therefore, if an investment is for six months, do not use six, but you would use 0.5 because six months is half of a year. If the investment is for three months, you would use .25 because three months is one quarter of a year. Therefore, SI for six months SI=($1,000x.04x.5)=$20.00 and SI for three months SI=($1,000x.04x.25)=$10.00.

5. Calculating compound interest involves more steps. Is the interest compounded daily? If so, you calculate the interest for one day. Remember there are 365 days in one year, so we need to divide our interest by 365, because calculations for interest are based on one year. Then you add the interest earned that day to the principal. The next day, you use the new amount of the principal plus one day of interest and multiply that total times the interest rate. The third day multiply the new principal calculated yesterday plus the interest earned yesterday times the current interest rate. You continue doing this for as long as the money is deposited.

6. Using the previous example of $1,000 at 4 percent, we will calculate a few days of interest. I=($1,000x.04x1)/365=11 cents. The first day we earned 11 cents in interest. The second day we will calculate our interest on a principal of $1,000.11. While this doesn't seem very significant, it can really add up over time. I=($1,000.11x.04x1)/365=11 cents; third day, I=($1,000.22x.04x1)/365=11 cents; fourth day I=($1,000.33x.04x1)/365=11 cents.

7. Final principal for one year of interest compounded daily at 4 percent is $1,040.81. Simple interest is $1040.00 for the same period. While this example is not a huge difference, if you invested larger sums, or invested over several years, the difference could be significant.

Tips & Warnings

• Formula for finding Simple Interest(SI):

• SI [Interest] = (P---R---T)

• where S.I. = Simple Interest, P = Principal or Sum of amount, R = % Rate per annum, T = Time Span

• Check for hidden fees at your financial institution before investing.

• Breaking a CD before maturity can result in all or most interest lost.

Resources

• Read this Article in Spanish
• Easy Calculation: Compound Interest Calculation Online
• Moneychimp: Compound Interest Calculator