How is interest calculated?

1. Simple interest: Interest is calculated only on the principal amount (the original amount deposited) . It doesn’t include any interest earned.
2. Compound interest: Interest is calculated on the principal amount, plus any interest that’s accumulated over time. Essentially, you earn interest on your interest!

Simple interest example.

• You deposit $100.
• The interest rate is 5% per year for three years.

Each year, you earn 5% on the $100 you deposited:

• Year 1: $100 + $5 = $105
• Year 2: $105 + $5 = $110
• Year 3: $110 + $5 = $115

Compound interest example.

• You deposit $100.
• The interest rate is 5% per year for three years.

Each year, you earn 5% on the total amount in your account (principal plus interest earned):

• Year 1: $100 + $5 = $105
• Year 2: $105 + $5.25 = $110.25
• Year 3: $110.25 + $5.51 = $115.76

Compound interest grows at a faster rate than simple interest because it’s based on the accumulated total, not just the principal amount of $100.

The amount of interest you earn depends on the following factors:

• the principal amount (the original amount, plus any future monies, deposited)
• the interest rate; usually expressed as an annual percentage rate (APR)
• the length of time the money is deposited (the interest earning period)
• whether the interest is simple or compound

Example one: high interest savings   .

A HISA earns you interest on the money you deposit. This interest can be compounded, meaning you earn interest on your interest.

Scenario: You deposit $10,000 into a HISA with an annual interest rate of 2.00% and don’t withdraw any money throughout the period.

Steps to calculate interest.

The formula uses the following values:

1. Principal (P): This is the amount of money you start with. In this case, it’s $10,000.
2. Annual Interest Rate (R): This is the yearly interest rate, which is 2.00%. It means you earn 2.00% on your $10,000 in one year.
3. Number of years (Y): We’ll calculate the interest for three years.

Calculation: 

Earning 2.00% interest per year on the total amount, here’s how you calculate compounded interest over three years:

1. Year 1: $10,000 + $(10,000 x 0.02) = $10,200
2. Year 2: $10,200 + $(10,200 x 0.02) = $10,404
3. Year 3: $10,404 + $(10,404 x 0.02) = $10,612.08

Summary: 

If you deposit $10,000 into a HISA with an annual compounded interest rate of 2.00%, you’d earn $612 in interest after three years.

 

Example two: one-year non-redeemable term deposit.

This type of deposit means your money is locked in for a year (meaning you can’t withdraw it for the duration of the term) and earn a fixed interest rate. The interest is usually simple interest, meaning it’s calculated only on the principal amount.

Scenario: You invest $10,000 in a one year non-redeemable term deposit with an annual interest rate of 4.55%.

Steps to calculate interest.

The formula uses the following values:

1. Principal (P): This is the amount of money you start with. In this case, it’s $10,000.
2. Annual Interest Rate (R): This is the yearly interest rate, which is 4.55%. It means you earn 4.55% of your $10,000 in one year.
3. Time (T): The period for the term deposit is one year.

The formula to calculate your interest is:

Interest = P × R × T

Here’s the calculation using our example:

Interest = $10,000 (P) x .0455% (R) x one year (T)

Summary:

If you deposit $10,000 into a one-year non-redeemable term deposit with an annual interest rate of 4.55%, you’d earn $455 in interest after one year.