How to Calculate Interest on a Short Term Loan

When taking out a new loan, whether short or long term, a borrower should know the principal balance of the loan as well as the interest rate charged. This helps the borrower to see the overall interest expense and calculate how much money is needed to repay the loan. Interest can be calculated as simple or compound; whether your loan's interest is simple or compound, you can calculate the interest on your new short term loan.

Step 1

Ask your lender for the interest rate and type of interest charged on your loan. You need to know the principal (or amount) of the loan, the interest rate, and if the interest is charged to you as simple or compound.

Step 2

Multiply the interest rate (convert to a decimal by dividing the percentage rate by 100) times the principal balance of the loan times the term in units of years. Then, divide that number by 100 to find out the interest charged during that time period. For example, if you borrow $10,000 at 6 percent interest for 1 year, you are charged $600 in simple interest.

Step 3

Calculate compound interest using this formula: P(1+(r/100)^n. Multiply the principal (p) by 1 plus the interest rate (as expressed in decimal points) and take that number to the "n" value (n representing the number of years of the loan). For example, $10,000 borrowed at 6 percent interest for 1 year will cost you $612.64 if the interest is compounded quarterly.

Tip

Use an online compound interest calculator, like the one found at MoneyChimp.com in the Resource section, to help you find out how much interest you will pay on the loan over varying terms. This can also illustrate how you can decrease your interest expense if you pay off the loan early.

Warning

Most banks do not charge simple interest and many charge interest that is compounded more frequently than monthly. Take note of that information when selecting a bank for your new loan, as well as when you make your calculations.

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