What Is a Periodic Interest Rate?
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The periodic interest rate means the interest rate over a specific period of time. The period rate helps you figure out how much interest accrues when interest compounds on a loan more than once per year. It also helps you figure out the interest when you take out a loan for less than a year, such as carrying a balance on your credit card.
Relationship Between Compound and Periodic Interest Rate
Compound interest occurs when interest is added periodically, rather than all at once at the end of the term. Once the interest is added to the account balance, that interest begins accruing additional interest. For example, if you have a savings account that pays you $10 of interest at the end of January, that $10 of interest begins earning additional interest in February and each month thereafter. To figure the amount of interest added each period, you need to know the periodic interest rate.
Calculating the Periodic Interest Rate
The periodic interest rate equals the annual interest rate divided by the number of times per year interest compounds. For example, many bank accounts compound interest monthly or even daily. If the annual interest rate is 3.65 percent and compounds interest daily, divide 3.65 percent by 365 days per year to find the periodic interest rate, which equals 0.01 percent in this example. But, check with your bank: According to the Consumer Finance Protection Bureau, some lenders use 360 days per year to figure the daily rate.
Function of Periodic Rate
The periodic rate determines how much interest you will owe or be paid each compounding period. For example, knowing the periodic rate for your credit card helps you calculate how much interest you will be charged if you carry a balance for a month. Alternatively, if you have money in a savings account, you can calculate how much interest you will earn for the month.
Periodic Interest Formula
To calculate how much interest you will earn or be charged over a period of time, divide the periodic rate by 100 to convert it to a decimal. Second, add 1. Third, raise the result to the power of the number of periods interest accrues. Fourth, subtract 1. Finally, multiply the result by the initial balance. For example, if the periodic interest rate is 0.01 percent, you have a $10,000 balance, and you will leave it for 30 days, divide 0.01 by 100 to get 0.0001. Second, add 1 to get 1.0001. Third, raise 1.0001 to the 30th power to get 1.003004354. Fourth, subtract 1 to get 0.003004354. Finally, multiply 0.003004354 by $10,000 to find $30.04 in interest would accrue.