Calculation of interest

[mik1973]

Been using microsoft money in order to calculate interest on loans. What i'd like to work out myself is how the decreasing capital and interest rates are calculated. For example (to keep things simple) If a £100 loan is taken out at an interest rate of 6% over 12 months the monthly payment (including interest) is £8.61. From the tables displayed the capital for the first month is £8.11 and interest of 50p -next month capital is 8.15 and interest is 46p- over the next ten months the capital amount is increased and interest decreases. Could someone please send me a formula to work out how these figures are arrived at .

Thanks,

Mick

 

[andycan]

i think you need to look into the rule of 78
its been a while but that should set you on the right track

 

[mik1973]

Hi Andy ,
Thanks for your reply-to be honest i have never heard of that paticular rule- any chance of a quick explanation of it? Will be doing a search on the net to try and find out more.
Thanks again,
Mick

 

[andycan]

its the method they use to calculate redemptions for regulated loans (under 25k now i think)
from there it should give you the formula of how interest and capital is calculated on a daily basis
its been a long time since i had to calculate it manually most do it via computer
now
maybe if you contact the office of fair trading they should be able to help
good luck

 

[mik1973]

Thanks again Andy,
I've come across some decent articles explaining the rule of 78 and can now understand how the monthly interest part is calculated. The only thing i need to work out now is how the total amount of interest on each loan is calculated. Using the formula i=prt wouldn't work as it doesnt' take into account the amount paid each month which would decrease the principal (which the interest is based on).
Can't believe how sad this must sound to some people- but i'd really like to get my head round this.
Mick

 

[Pippppin]

Rule of 78

1 Calculate the total amount of interest payable over the life of the loan

2 Take the number of months, and assign each month in reverse order to the month you are paying off (eg for a two year loan of 24 months, the first month is assigned 24, the second 23 and so on)

3 Add all the months (eg. 24+23+22+.......1) = 300

4 To calculate the proportion of interest payable each month - divide the month number by 300 (in this case)
eg for the 4th month (assigned number 21), the ratio is 21/300

5 Interest paid in 4th month = (21/300) x Total interest

PS It is called the "Rule of 78" because if you add the month numbers for one year (12+11+10+...1) you get 78

Hope this is clear. It is a clever way for banks to penalise people who repay loans early - since they have paid a disproportionate amount of interest.

 

[mik1973]

Hi Pippin,
Managed to find a few articles explaining the above thanks. Would appreciate if you could describe how i can calculate the amount of interest on a loan. For example on a 10,000 loan at a rate of 12% over 12 months the total amount of interest paid would be 661.85-- i'm just not sure how that figure is arrived at .
Cheers,
Mick

 

[andycan]

10k at 12% is 1200 i suspect you are using the APR to figure it out and that is then incorrect, to calculate these types of loans one has to use the true rate of interest if you pay 661.85 then your true rate of interest is 6.6%
the apr may well be 12% because thats a refection of what you end up paying over the 12 month (money value as opposed to interest pay back)