How to Convert Monthly Interest Rates to Yearly

Long-term financing, such as auto loans or home mortgages, provides many individuals across the country with the resources they need to finance critical purchases. In many situations, this borrowing platform can be life-changing. That being said, it is important to assess the impact that interest will have on the overall sum of money owed. Depending upon how interest compounds on your loan, you can use a few simple calculations to convert monthly interest rates to annual percentages and vice versa.

When you take out a mortgage or any other form of long-term borrowing, you are assigned an interest rate for your loan. This percentage value represents a specific portion of your loan that will be added back onto your principal balance as a form of "premium" for the privilege of borrowing.

When interest is attached to a loan, specific details will also be included relating to how interest compounds, or accrues on top of the principal balance. Generally speaking, interest will either accrue on a monthly or yearly basis. If, for example, your loan has compounding monthly interest, the specific amount of interest apportioned for each month of borrowing will be added back on top of the principal before the next month's balance is calculated.

This differs significantly from annual compounding, in which interest is calculated as a lump sum based on the current annual balance. So, for example, if a $200,000 loan had a 5 percent interest rate that compounded annually, a total of $10,000 would be added back on to the balance at the end of the year.

Based on this information, you can determine for yourself that calculating monthly interest rates on annually compounding interest is significantly easier than loans where interest compounds monthly.

To convert a yearly interest rate for annually compounding loans, you can simply divide the annual interest rate into 12 equal parts. So, for example, if you had a loan with a 12 percent interest rate attached to it, you can simply divide 12 percent by 12, or the decimal formatted 0.12 by 12, in order to determine that 1 percent interest is essentially being added on a monthly basis. You can simply inverse this process to convert a monthly rate to annual.

That being said, a more complex formula must be used if interest rates are compounded monthly. In order to calculate this, you will first need to convert the monthly interest rate into a decimal-formatted figure. In order to do this, divide the percentage rate by 100. Following this, you will need to add 1 to the figure and then raise this number to the 12th power. Once this is completed, you can subtract 1 from the resulting number and then multiply the figure by 100 to determine the annual interest rate.

As an example, consider the following: your current monthly interest rate on a loan where interest compounds monthly is a significant 2.5 percent. Divide this figure by 100, which yields the number 0.025. Add 1 to this sum and then raise this to the power of 12. After doing so, you will arrive at the number 1.3448. Subtract 1 from this figure, and then multiply the result by 100. So, your final calculation would be 0.3448 *100 = 34.46. Therefore, your monthly compounding 2.5 percent interest will ultimately become an annual interest rate of 34.46 percent.