How do I work out interest on 3.9% AER over 4.5 years

Tilly75

Can someone please tell me how I work out the interest owed on £11349.66 over 4.5 years at a rate of 3.9%. My sister loaded me the money and I agreed to pay back the money including interest at a rate of 3.9% AER(interest paid net of income tax at the basic rate). Any help would be much appreciated

Lokolo

£13,481.95

(which is 11349.66 * 1.039 ^ 4.5 using the formula capital * rate ^ period)

CLAPTON

will you be paying back the money at the end of the 4.5years or are you paying her back monthly?

Tilly75

Paying back full amount.

The reason I have asked the question is that (and please excuse my limited knowledge) I was under the impression that AER meant it was 'taxable' so would I need to deduct tax or is that not applicable? This is where my confusion is steaming from (mainly around AER) and I want to ensure that I am paying her the correct amount of interest as if she had paid into a savings account which was 3.9%AER. Very much appreciate the responses

CLAPTON

well if she is a normal tax payer then she wouldn't receive 3.9% as they would deduct tax at 20% so she would only receive 1705 in interest

Lokolo

Yep mine includes compounding and no tax + the original capital amount.

Tilly75

Ok thank you - I will check what level of tax she is on as she is currently studying for her PHD but I believe the university part sponsers/pays her so unsure what tax level is applicable to her (i.e. student or normal).

CLAPTON

students pay the same tax as everyone else; however if her taxable income is less than 7475 per annum then she can register her savings to receive interest gross (normally Ph.D bursaries are tax free)

aktivemac

Not sure the above calculation is correct.

I presume you'd want to be paying back the loan over that 4.5yrs - if that is the case then I disagree with the simple compound maths used above as that would assume interest only with full repayment at the end of 4.5yrs (i.e. a lot more interest).

Assuming a full repaying loan over 4.5yrs (without taking off the tax benefit you are suggesting) then it would be a flat payment of £229.50 each month for 54months. Total repayment would be £12,393 - of which interest would be: £1043.43.

[I did this calculation myself in excel and confirm using an online loan calculator - goto "money.guardian.co.uk/calculator/form/0,,603119,00.html" [sorry, can't post links as a new user] and insert your loan amount, 3.9%, monthly and 54 payments and you get the same answer]

Using excel you can break this payment into interest and principal and then assume you net 20% tax off the interest and you get a lower total repayment of: £12,184 - with total interest of £835.

Given the reduction only hitting the interest portion then it results in non-fixed monthly payments - starting at £222 and finishing at £229 (ish). This is due to principal being a bigger portion of the pot as you move closer to the end.

Maybe the easiest may is just agree to pay back the full £229.50 each month and as a "repayment bonus" you get the 20% interest back at the end of 4.5yrs (£208.79).

Just a suggestion, as it would make it easier to setup a standing order rather than worrying about variable payments.

Standard disclaimer: please take all this with a pinch of salt as I am not a financial advisor and take no reponsibility for use of these figures.


Edit:

On the tax point - interest paid to a person from a savings account is usually paid net of 20% basic tax rate (witholding tax). So the only argument is, given this isn't a real loan and you are paying her back as personal agreement by you paying her less the 20% tax she would be getting the same interest as if she had that amount (reducing obviously) in a 3.9% savings account that is paid net of tax.

From a HMRC stand-point whatever you pay her is additional income and should be taxed at her marginal rate and therefore would suggest you should pay the full pre-deduction amount (£229.50) and leave her to flag the extra income to HMRC in her self assessment forms. Depends how 'by the book' you are intending to be, if its purely a verbal agreement between siblings then maybe she's happy with the net tax amount and you make a 20% saving on the interest you pay her. Note: *I in no way condone any form of tax evasion, but just highlighting the implication of your various options*.

If she earns less than the personal allowance threshold each year (as stated £7475 per year) then as long as the annual interest (on average circa £230 per year) does not take her income over this level then she is eligible to receive gross interest on savings account, and therefore you should pay her the full gross amount (£229.50) as this is what she would get on a savings account once eligible for gross interest (again assuming her savings started at £11,349.66 and reduced to 0 over 4.5yrs....)

Richard.

Lokolo

aktivemac wrote: »

Not sure the above calculation is correct.

I presume you'd want to be paying back the loan over that 4.5yrs - if that is the case then I disagree with the simple compound maths used above as that would assume interest only with full repayment at the end of 4.5yrs (i.e. a lot more interest).

Assuming a full repaying loan over 4.5yrs (without taking off the tax benefit you are suggesting) then it would be a flat payment of £229.50 each month for 54months. Total repayment would be £12,393 - of which interest would be: £1043.43.

But Richard, the OP hasnt said that they are paying at a monthly rate or anything, just that they have X and want to know how much it would have made at Y interest rate over 4.5 years. As though it is a savings account.

Your calculation is a loan calculation, not a savings calculation.

aktivemac

Lokolo wrote: »

Your calculation is a loan calculation, not a savings calculation.

Accepted. If the OP wants to borrower the full loan amount for 4.5yrs and only pay back the loan at the very end, then I agree with your compounding approach. This would mean it was effectively an interest-only loan with only interest paid back over the 4.5yr term and then the full £11k paid back at the end of the 54month period in 1 payment.

Given it seems to be a loan over 4.5yrs I assumed he would want to pay it back over time so he is left with nothing to pay at the end and paying the correct interest on the reducing balance over time.

Both ways are correct, just depends what the OP wants to do. Is this a new loan? Or is it money loaned to you 4.5yrs ago that you now want to pay back with the correct interest attached? If its the former then I would suggest approaching it per my original post (i.e. £229.50 a month repayment). If its the latter, and you want to repay her money she gave you 4.5yrs ago but now including the correct interest, then you should repay the amount that Lokolo suggested in his/her original post.

Can the OP clarify?

Thanks,
Richard.

[Lokolo: Sorry, didn't mean to suggest your maths was wrong - just depends what's trying to be acheived I guess.]