POSTED BY January 6, 2011 8:53 pm COMMENTS (3)
ONI WOULD LIKE TO CALCULATE (IN HEART OF HEART) THE ANNUALISED INTEREST ON THE PRINCIPLE LOAN WHEN IT INDICATES INTEREST ON MONTHLY REDUCING. JUST LIKE THE LAW OF 72! ANY IDEA?
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Interest on monthly reducing balance, intt calculated quarterly, bimonthly, semiannually all these are ways of calculating/compounding a nominal yearly intt rate. In none of these methods the intt rate would go below the annual nominal rate but will keep on increasing a little bit depending on the number of times the compounding is increased. So a 12% nominal compounded monthly is akin to 1% per period( here a month) and compounded for 12 periods. So the effective annual intt rate would be more than 12%. As you increase the number of periods within a year say from quarterly to monthly, from monthly to daily and the maximum possible as continuous i.e. compounding infinitesimally high number of times, the effective intt rate will keep on creeping up a notch.
As a thumb rule for intt rates in the range 8 to 12% even with the maximum steps i.e. continuous compounding the effective rate doesn’t move up more than o.5% from the nominal rate for the year.
So daily reducing, monthly reducing balances doesn’t mean that the intt rate in decreasing. Yes the total intt may come down because the principal amount is reducing in more steps.
The question is not clear. Can you please elaborate?
One of my friend took Contigency loan at 12% monthly reducing where in he is supposed to pay the EMI. He quickly asked me how much additional he will be paying over and above the principle. Actally I was looking for a quick reference formula rather than extending this calculation to spreadsheet.
Hope it clarifies…