The Ways to Calculate Compound Interest

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Under the concept of compound interest, both interest payments and principal balances earn money.
Under the concept of compound interest, both interest payments and principal balances earn money. (Image: Jupiterimages/Photos.com/Getty Images)

Compound interest results in larger loan repayment balances or investment returns since it considers both the principal and accumulated interest. Calculating compound interest involves taking the interest rate percentage and multiplying it by an accumulated balance. The compound interest formula calculates the total amount of interest in several ways. With certain given variables, the compound interest becomes isolated when slightly varied methods are used. You can also calculate compound interest in longhand fashion with shorter loan or investment periods.

Longhand

One of the ways to calculate compound interest involves multiplying the interest rate percentage by an accumulated balance. This calculation method is most effective when the amount of periods where interest will accumulate is small. For example, a $1,000 investment with a six percent annual interest rate that will mature in three years is a good candidate. Assuming the interest compounds annually, the $1,000 multiplies by .06 to arrive at an accumulated balance of $1,060. The next calculation would multiply $1,060 by .06 to arrive at a balance of $1,123.60. A final calculation of $1,123.60 times .06 gives an accumulated balance of $1,191.02. The total compound interest is $191.02.

Total Amount

The compound interest formula shows that the total amount equals the principal times one plus the interest rate squared by the number of periods. Calculate the total amount using the formula when you already know the principal, interest rate and number of periods. If the interest rate is six percent, the principal is $1,000 and the number of periods is three, then multiply 1.912 by $1,000. This results in $1,191.02. Subtract the principal from the total amount for a compound interest of $191.02.

Principal

Without a principal balance, the other variables plug into the compound interest formula. For example, if a given total amount were $1,210, with an interest rate of 10 and two periods, the figure of $1,210 divides by 1.21. Adding one and .10 gives a calculation of 1.10. Multiply 1.10 by itself to arrive at 1.21. After dividing $1,210 by 1.21, the principal balance is determined to be $1,000. In this case, the compound interest is $210.

Interest Rate

The amount of compound interest is also determined when the interest rate is calculated. For example, if the total amount given were $1,210, with a principal balance of $1,000 and two periods, $1,210 divides by $1,000. The result of the calculation is 1.21, which substitutes into the other side of the equation. The square root of 1.21 would then be determined, which is 1.1. When the number one subtracts from 1.1, it yields .10 or 10 percent, giving the compound interest rate.

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