When you calculate interest, you learn what’s happening with your money. The process is easy, but it can get tricky if you want more than a simple interest calculation. Learn how interest calculations work for different transactions, including loans and deposits at the bank.

### How to Calculate Interest

The simplest way to calculate interest is to multiply the periodic interest rate by the principal amount. Assume you’ve borrowed $100 (or deposited $100 at the bank) at 5% for one year. How can you calculate interest in this situation?

- Periodic interest rate = 5%
- Principal amount = $100
- $100 x 5% = $100 x .05 = $5

The interest after one year is $5.

### Calculate Interest Monthly

What if we’re talking about monthly interest costs? Things get more complicated, and you’ll have to adjust your periodic interest rate. Since there are 12 months (or periods) in a year, divide 5% by 12. The result is roughly .4167%.

- Periodic interest rate = .4167%
- Principal amount = $100
- $100 x .4167% = $100 x .004167 = $0.4167

The interest after one month is roughly $0.4167. If you pay this every month, you will have paid roughly $5 over the course of one year.

### Shrinking Balances and Interest Calculations

What if you repay the loan by $10 per month? Will your interest costs change? For this calculation, you have to adjust the principal amount by reducing it each month. Let’s assume you’ve made 5 payments (or $50 total). What will your interest cost be the following month?

- Periodic interest rate = .4167%
- Principal amount = $50
- $50 x .4167% = $50 x .004167 = $0.2084

The interest for that month is roughly $0.2084. If the loan balance decreases throughout the year, you’ll end up paying less than $5 in interest.

### Standard Loan Payments

When you borrow money, you often repay with a flat monthly payment. For example, auto loans and home loans generally come with a fixed monthly payment, and that payment is an important part of the decision whether or not to buy (but not the only factor you should consider).

When these loans are made, the payment is calculated so that all interest and principal will be paid over a specific time period -- 6 or 30 years, for example. The process of paying down loans this way is called amortization, and it’s worth examining if you’ll borrow money to make a major purchase.

*By Justin Pritchard / About.com*