Interest on loans and savings accounts are usually expressed on a yearly basis. Estimating what you will pay or earn in interest is usually a simple matter of dividing your annual rate by 12. However, financial institutions often calculate interest on a daily basis and pay out "interest on interest," otherwise known as "compound interest." Research the terms of your loan or savings account so you know which calculation to use.
Simple Interest Calculation
To calculate simple interest paid monthly, multiply your loan or savings balance by the interest rate. For example, if your loan amount is $10,000 and your annual percentage rate is 10 percent, the interest over one year is $1,000. Divide that amount by 12 to calculate the amount of interest per month, which is $83.33. Often, a monthly loan payment will be more than the cost of the interest. For example, on a loan payment of $100, $83.33 will go to interest, but $16.67 will go to the principal. Your loan balance is therefore reduced to $9,983.33, and the following month your interest is $83.19. As a result, as you pay down your principal the amount of interest you are charged will be less.
Daily Periodic Rate
Months have as few as 28 or as many as 31 days. Financial institutions often come up with a monthly interest amount using a daily periodic rate. A loan that has an annual interest amount of $1,000 is divided by 360 or 365 days, depending on the bank, which results in a daily rate of $2.78 or $2.74. Interest is then charged by the number of days in the month. A daily interest charge of $2.78 would result in a $86.18 interest charge for a month with 31 days and a charge of $77.84 for a month with 28 days.