So how is interest worked out then????

skylight

:question: :think:

So how do the banks work out interest then?? and whats the formula??

If I wanted to save £100 per month in an ISA at 6%, how would I work out how much interest I would recieve after the first year?

And does it really make any difference if the interest is monthly or yearly??


So - its a dumb question - but all polite answers will be gratefully accepted!
(rude ones will be just accepted!)

Reaper

If interest rates were equal a monthly interest account would be better than an annual one because it would compound (i.e. you would earn interest on the interest). However in practice the monthly ones will pay slightly less for that very reason.

The figure to look for is the AER (Annual Equivilent Rate). Regardless of when the interest is paid that tells you how much it will be worth after a year.

So £100 in a tax free ISA at an AER of 6% would be worth £106

Now a common myth is that monthly is better because if you surrender half way through the year at least you would get 6 months interest. Not true. In practice interest on accounts are invariablely worked out daily. The interest is just applied monthly/yearly or when you close the account. So it makes no difference which type of account you have.

grumbler

charlotte664 wrote:

So how do the banks work out interest then?? and whats the formula??

If I wanted to save £100 per month in an ISA at 6%, how would I work out how much interest I would recieve after the first year?

‘a’ -monthly amount saved
‘y’ - yearly interest (decimal notation: for 6% y=0.06)
‘I’ - total interest after one year

I=a*y/12+a*2*y/12+…+a*12*y/12=
=a*y*(1+2+..+12)/12=a*6.5*y

£100*6.5*0.06=£39

This formula does not take account of compounding interest but difference is very small.

Reaper

Ah, sorry. I missed the key phrase in your question saying you wanted to save £100 per month. The money you first put in will earn 6% for the full year but each subsequent contribution will have less and less time to earn interest before the end of the year, hence Grumblers scary looking formula.

You might prefer to have it worked out for you. Click here for a calculator.