Section 8.1 Loans and Interest
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Ordinary Interest Method
When money is borrowed for less than a year, calculating the interest is not
as simple as calculating a single payment loan.
One common way to calculate loan interest for fractions of a year is to use
the ordinary interest method. In the ordinary interest method, the interest is
calculated assuming that each month has 30 days, for a total of 360 days in the
year. This is done to make calculation easier than if all 365 days are considered.
For most applications, this method is accurate enough for the calculation. The
ordinary interest method is sometimes called the banker’s interest method or
simply the banker’s rule.
To calculate ordinary interest, the number of ordinary interest days is divided
by 360. The result will be the fraction of the year that will be multiplied by the
annual interest rate. This idea can be expressed as shown in the formulas that
follow:
term =
number of days of the loan
360
I = Prt
Example 8-1C
See It
Shelby borrowed $1,750 from her cousin using the ordinary interest method.
They agreed that Shelby would pay an annual interest rate of 4.5%. She would
repay the loan in seven months. How much interest will Shelby pay on the loan?
Strategy
Use the formulas:
term =
number of days of the loan
360
I = Prt
fyi
Before committing to
a loan, make sure you
understand the interest
and how many payments
you will be making.
Promissory Note
The borrower, Mikhail Nikolai, borrows from the lender, Dmitri Nikolai, the sum
of $3,300 for a period of one year.
Mikhail will pay an annual interest rate of 5.35%, and promises to pay the loan in
full, including all applicable interest, at the end of one year.