When planning your finances, especially borrowings, interest rate levy and computation remains of utmost concern. Rightly so as it can affect your monthly outflows in the form of EMIs and impact the overall loan liability. Under various investment frameworks as well, your applicable interest rate and computation method are important as it defines the returns an individual earns.
One of the most common methods for interest computation in the financial market is the compound interest calculation method.
Compound method of interest calculation
Compound interest is a method of calculation that considers the principal amount and previous interest accrued for further interest computation. As the name suggests, the interest calculated is compounded over time with each computation cycle.
It can thus be understood as a calculation method that computes interest not only on the principal value but also on the interest value. Therefore, the principal for each compounding instance changes as per the previous computation. The financial institution may select multiple compounding periods for a year, usually monthly, quarterly, or semi-annually.
Here’s an illustration of interest calculation as per compounding interest-
If the principal amount is Rs. 50,000, and the initial interest calculated on Rs. 50,000 at 10% is Rs. 5,000, the next principal value for interest calculation would be Rs. 55,000 (Rs. 50,000 + Rs. 5,000). Consequent interest calculation at 10% would be Rs. 5,500, and principal value thereto for next compounding period would be Rs.60,500 (Rs. 55,000 + Rs. 5,500), and so on.
Under the compound interest method, the standard formula used for liability calculation goes as –
A = P [1+ (r/n)]^nt
Here, A refers to the total amount accumulated for the concerned number of years, including the interest value. P stands for the initial principal amount, and r indicates the applicable rate of interest. N denotes the number of times interest is to be compounded, and t refers to the number of years involved.
As per this, five essential factors can be derived as the most critical contributors to compounding interest calculation.
Four essential factors that impact compound interest calculation
- Principal value
Even though compounding interest calculation indicates variable principal consideration, the loan principal availed remains crucial. The total interest payable is an outcome of the amount borrowed at the outset. Thus, if a short-term personal loan can help you during an emergency, it is best to stick with a smaller amount than high-value, long-term borrowing.
- Interest rate applicable
The interest rate at which you have availed of a loan is another crucial contributor to your total liability accrued as per compound interest calculation. A low rate of interest would mean reduced interest calculation despite compounding.
Especially when availing of collateral-free advances like personal loans, it is best to check out ways in which you can avail better interest rates for your personal loan.
Choosing the right personal loan lender offering the lowest rate is one of the smart ways to initiate your search for an affordable loan option. For instance, lending institutions like Bajaj Finserv provide instant personal loans at attractive and competitive rates along with other nominal charges. You must check out the Bajaj Finserv EMI overdue charges and other additional fees for better assessment. Using the Bajaj Finserv helpline number can allow access to all pertinent information related to these loans.
The lender also makes this entire process of financing hassle-free and less time-consuming with their pre-approved offers. One can avail of these offers on various financial products, including personal loans, business loans, and credit cards. You need to provide only your name and contact details to check your pre-approved offer.
When availing of a personal loan without a CIBIL score, you mays find it challenging to secure funding at low rates. It is thus advisable to check out the things you can do to improve your personal credit score. It is, nevertheless, possible to avail of an instant loan for a low CIBIL score as well, albeit at unfavorable borrowing terms.
- Loan tenor
The loan tenor you agree to repay your loan over also contributes significantly to determining your total interest payable on this advance. A short tenor would yield a low-interest accumulation and vice versa, even with interest calculated under this compounding method.
- Compounding frequency
One of the most crucial factors contributing to interest calculation under this compound interest method is the selection of compounding frequency. Interest accumulation under monthly compounding frequency is higher than that under quarterly compounding.
Even though the compound interest method leads to higher interest accumulation, a prudent borrower can still save on interest payable through smart repayment choices. Make sure you know your options regarding prepayment facilities and the Flexi loan feature before applying for an affordable borrowing experience.