Interest rates are complex. But is it really 12?

I had a good chuckle while reading this epic discussion thread on the Bogleheads Investment Forum: Does a home mortgage use Simple or Compound Interest? It sounds a like factual question, as in "Is Miami located to the north or south of Boston? You look at a map and say "south" and everybody would agree.

Or is it like the difference between 0 and null? To answer the question we first need to understand what is a simple interest loan, what is a compound interest loan, and what are the characteristics of each.

Simple Interest Loan In a simple interest loan, the interest in a second period is not affected by the interest in the previous period. You just multiply the principal Compound interest and answer the rate and the years to get the total interest. Compound Interest Loan In a compound interest loan, the unpaid interest at the end of the first period is added to the principal for the second period, allowing the interest to compound.

A higher rate or a longer term in a compound interest loan costs more than just a straight multiple. Home Mortgage In a typical home mortgage, your monthly payment first covers the interest for that month, with the remainder being applied to principal.

Interest does not add to the principal for the next month. If the mortgage is interest-only — yes, there are those mortgages — it behaves exactly like a simple interest loan. If the rate is twice as high, your total interest in each period and over the life of the loan is twice as much. If the term of the loan is twice as long and the rate is the same, your total interest over the life of the loan is also twice as much.

Principal Payments Paying down principal by an amortization schedule makes it more tricky. Doubling the interest rate more than doubles the total interest over the life of the loan.

Doubling the length of the loan also more than doubles the total interest over the life of the loan. Making a principal payment early has a compounding effect.

The compounding effect comes from varying principal payments, not from compounding interest. Between two mortgages, if you keep principal payments the same, they behave like simple interest loans. Conclusion A typical home mortgage is still a simple interest loan even though it feels like compound interest.

The compounding feel comes from varying principal payments. Why does a seemingly simple factual question elicit completely opposite answers?

The principal payments do. This is the same situation as in asking whether the k loan interest is double taxed. There are two taxes, unrelated, and you still pay the same two taxes whether you borrow from your k or not.

Focusing on the wrong thing leads people down the wrong path. Lowering the rate has a compounding effect. Shortening the term has a compounding effect. Pre-paying principal also has a compounding effect.

Flickr user hannah8ball] Say No To Management Fees If an advisor is charging you a percentage of your assets, you are paying x too much.

Learn how to find an independent advisor, pay for advice, and only the advice:Compound interest is calculated by multiplying the principal amount by one plus the annual interest rate raised to the number of compound periods minus one.

The total initial amount of the loan is. Simple Interest and Compound Interest Multiple Choice Questions and Answers: Ques. Mr. Yogendra gave some money at simple interest and at the end of 10 years, got back twice the pfmlures.com rate percent per annum is: (a) 2% (b) 4% (c) 5% (d) 10% Ans. (d) Ques.

Find the compound interest on Rs for 2 years, compounded annually at % per annum. (a) Rs Mathematics (Linear) – 1MA0 COMPOUND INTEREST AND DEPRECIATION Answer all questions. Answer the questions in the spaces provided – there may be more space than you need.

Calculators may be used. Henry invests £ at a compound interest rate of 5% per annum.

Compound Interest is calculated on the initial payment and also on the interest of previous periods. Example: Suppose you give \$ to a bank which pays you 10% compound interest at the end of every year.

After one year you will have \$ + 10% = \$, and . Compound Interest Formula. Compound interest - meaning that the interest you earn each year is added to your principal, so that the balance doesn't merely grow, it grows at an increasing rate - is one of the most useful concepts in finance.

Compound Interest [ 2 Answers ]. If an investment is up 88% over 6 years (simple interest) what is the compound rate of growth per anum.

My question was not for the purposes of homework.

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Compound Interest - Aptitude Questions and Answers