# How are interest rates calculated yearly?

I once thought interest rates were a monthly charge. For instance a 5% interest rate means 5% of the loan added to the principal every month.

Then I thought it was an annual charge that remains the same for the duration of the loan. So a 5% interest rate for a 100,000 dollar loan would be 5,000 a year.Is this correct? Or is the interest rate charged on the current balance? If so what is the formula for calculating something that decreases yearly? Very confused.

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• Interest rate is usually applied from each payment, recalculated based on the unpaid balance.

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• Use TMV (time value of money) formulas - in excel, on calculators, or in actual math form. For a decreasing balance: Amount owed x (1 + interest rate based on the days interest due) = New amt due ... then subtract the payment you make, and that = the new balance you will be paying interest on the next time you make a payment.  {Work with it, and it will become clear.}

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• Interest rates have two components.

Annual percentage rate

Compound date (simple, daily, monthly, annually).

If your interest rate is 5% APR (annual percentage rate) and has simple interest or compounded annually, then you are correct that 5% is 5% but most loans have daily compounding.  Which is

5% / 365 or .000189 per day.

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• The current balance. So when the balance is 100,000 and the rate is 5%, it's 5,000 a year. When the balance is 20,000 and the is 5%, it's 1,000 a year.

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