Calculating interest month-by-month is an essential skill. You’ll often see interest rates quoted as an annual percentage, but sometimes it’s more helpful to know exactly how much that adds up to in dollars and cents. We commonly think in terms of monthly costs.
For example, you have monthly utility bills, food costs, or a car payment. Interest is also a monthly (if not daily) event, and those recurring interest calculations add up to big numbers over the course of a year. Whether you’re paying interest on a loan or earning interest in a savings account, the process of converting from an annual rate to a monthly interest rate is the same.
Monthly Interest Rate Calculation Example
To calculate a monthly interest rate, divide the annual rate by 12 to account for the 12 months in every year (see Step 2 in the example below). You'll need to convert from percentage to decimal format to complete these steps.
Example: Assume you pay interest monthly at 10% per year. What is your monthly interest rate, and how much will you pay (or earn) on $2,000?
- Convert the annual rate from percentage to decimal format (by dividing by 100): 10/100 = 0.1 annually
- Divide the annual rate by 12: 0.10/12 = .0083
- Calculate the monthly interest on $2,000: 0.0083 x $2,000 = $16.60
- Convert the monthly rate in decimal format back to a percentage (by multiplying by 100): 0.0083 x 100 = 0.83 percent annually
Want a spreadsheet with this example filled in for you? See the free Monthly Interest Example spreadsheet, and make a copy of the sheet to use your own numbers. The example above is the most basic way to calculate monthly interest rates and costs for a single month.
Interest can be calculated monthly, daily, annually, or over any other period. Whatever period is used, the rate you’ll use for calculations is called the periodic interest rate. You’ll most often see rates quoted in terms of an annual rate, so you’ll need to convert to whatever periodic rate matches your question or your financial product.
With many loans, your loan balance changes every month. With auto, home, and personal loans, you gradually pay down your balance over time, and you usually end up with a lower balance each month.
That process is called amortization, and an amortization table helps you calculate (and shows you) exactly how much you pay in interest every month.
Over time, you’ll notice that your monthly interest costs decrease—and the amount that goes towards your loan balance increases.
Home Loans and Credit Cards
Home loans can be complicated. It is good to use an amortization schedule to understand your interest costs, but you may need to do extra work to figure out your actual rate. You might know the annual percentage rate (APR) on your mortgage, but APR can contain additional costs besides interest charges (such as closing costs). Also, the rate on adjustable-rate mortgages can change.
With credit cards, you can add new charges and pay off debt numerous times throughout the month. All of that activity can make calculations cumbersome, but it’s still worth knowing how your monthly interest adds up. In many cases, you’ll use an average daily balance, which is the sum of each day’s balance divided by the number of days in each month (and the finance charge is calculated using the average daily balance). In other cases, interest is charged daily (so you calculate a daily interest rate—not a monthly rate).
Interest Rates and APY
The annual percentage yield (APY) accounts for compounding, which is interest you earn as your account grows due to interest payments. APY will be higher than your actual rate unless interest is compounded annually, so it will give an inaccurate result. That said, APY makes it easy to quickly find out how much you’ll earn annually on a savings account with no additions or withdrawals.
You can use the same interest rate calculation concept with other time periods:
- For a daily interest rate, divide the annual rate by 360 (or 365, depending on your bank).
- For a quarterly rate, divide the annual rate by four.
- For a weekly rate, divide the annual rate by 52.
Be sure to use the interest rate in your calculations—not the annual percentage yield (APY).
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