Are you planning to apply for a business loan? Before you do, there are a few things you must consider first. On top of the list is the business loan interest rate. You need to take interest rates into account because they will determine the total amount of money you will owe and eventually have to pay. Knowing how to calculate the interest rate on a loan is helpful for business owners. But you need to understand what drives your rates up or down, so you can come up with ways to lower your interest and, consequently, the total cost of your business loan.
What is an Interest Rate?Before we get to the nitty-gritty, let’s begin by defining the subject at hand. What is interest rate exactly? Essentially, interest rates let lenders earn from the loans they issue to worthy applicants. A payment agreement that stretches over a specified period will entail the borrower paying a portion of the principal amount owed and a portion of the interest rate every month. The loan agreement ends once both the principal amount and its corresponding interest rate have been paid. Paying for interest means you’re paying more than the amount you borrowed. As such, you want your interest rate to be as low as possible to minimize your overall expenses.
How to Calculate Interest Rate on a LoanThink of interest rates as the cost of borrowing money. They come in two main categories: fixed and floating. The former stays constant throughout the loan term, whereas the latter fluctuates relative to a reference rate. Meanwhile, in terms of calculation, there are two more types, namely simple and compound. Simple interest calculation follows this formula:
Principal x interest rate x loan termTo illustrate, let’s say that you borrowed ₱10,000 that has to be paid in 2 years. The agreed interest rate is 3%. Therefore:
Simple interest: ₱10,000 x 3% x 2 = ₱600This means you’ll be paying ₱600 on top of the ₱10,000 you borrowed. Your goal is to pay the combined portions of the principal loan and interest rate every month on time and in full. Otherwise, you might be charged a late payment fee, or your outstanding balance would gain interest. If the latter happens, you would have to contend with ballooning compound interest, which is basically interest on interest.