Financing costs are the price of borrowing money, whether it be from a bank, credit card company, or other financial institution. Financing costs can take many forms, but most often come in the form of interest charges. Knowing how to calculate financing costs and understanding when certain calculations are necessary is an important part of managing personal finances.

When calculating simple interest on a loan, you will need to know the principal amount borrowed, the annual interest rate (also known as the nominal rate), and the length of time for which the loan is held. The formula for calculating simple interest is: I = P × R × T, where I is equal to total accrued interest, P stands for principal amount borrowed, R represents annual interest rate, and T represents the length of time for which the loan is held.

How to calculate simple interest

Compound interest calculations are a bit more complicated, but still relatively simple to understand. Compound interest is calculated by adding the previously accumulated interest back into the principal amount each period and then calculating the new total loan balance with the updated principal amount. The formula for compound interest is A = P (1 + r/n)^nt where A is equal to the final loan balance, P stands for principal amount borrowed, r represents annual interest rate, n refers to number of times compounding occurs per year, and t stands for time in years that the loan is held.

How to calculate compound interest

The effective annual rate (EAR) is a standardized measure of the cost of borrowing money over a year. It takes into account the frequency with which interest compounds and adjusts the nominal interest rate to give an accurate representation of the total cost of borrowing for that year. The EAR formula is: EAR = (1 + r/n)^n – 1, where r stands for nominal interest rate and n refers to number of times compounding occurs per year.