Cumulative Interest

What Is Cumulative Interest?

Cumulative interest is the sum of all interest payments made on a loan over a certain period. On a amortizing loan, cumulative interest will increase at a decreasing rate, as each subsequent periodic payment on the loan is a higher percentage of the loan's principal and a lower percentage of its interest.

Utilizing Cumulative Interest

Cumulative interest is some of the time used to figure out which loan in a series is generally efficient. In any case, cumulative interest alone doesn't account for other important factors, for example, initial loan costs (on the off chance that a lender pays these costs personal rather than rolling them over into the loan's balance) and the time value of money.

The time value of money (TVM), otherwise called the current discount rate, is a core concept in finance. It centers on the idea that money accessible at present is worth more than a similar amount from here on out, due to its true capacity earning capacity. If money can earn interest, any amount is worth more the sooner it is received.

The overall formula for TVM is: FV = PV x (1 + (I/n)) ^ (n x t)

FV = Future value of money

PV = Present value of money

I = interest rate

n = number of compounding periods each year

t = number of years

Cumulative Interest versus Compound Interest

While cumulative interest is added substance, compound interest can be considered "interest on interest." The formula is as per the following:

Compound Interest = Total amount of Principal and Interest in future (or Future Value) less Principal amount as of now (or Present Value)

                  = [P (1 + **i**)n] - P

                  = P [(1 + **i**)n - 1]

(Where P = Principal, i = nominal annual interest rate in percentage terms, and n = number of compounding periods.)

For instance, what might the amount of interest be on a five-year loan of $10,000 at an interest rate of 5% that compounds annually? In this case, it would be: $10,000 [(1 + 0.05)5] - 1 = $10,000 [1.27628 - 1] = $2,762.82.

Choosing compound interest will cause a sum to develop at a quicker rate than simple interest, which is calculated exclusively on the principal amount. This happens on the grounds that, when interest is compounded, the money earned through interest is added to the principal periodically, so that more interest is earned in the next period. This cycle rehashes the same thing, leading to bigger gains due to interest.

Cumulative Interest and Measures of Bond Performance

While cumulative interest is one method of working out how well a bond investment is playing out, coming up next are more far reaching yield methods: nominal yield, current yield, effective annual yield, and yield to maturity.

Cumulative Interest Example

Cumulative interest alludes to all of the interest earned or paid over the life of a security or loan, added together. Assuming that you borrowed $10,000 at an interest rate of 3% annually, you'd pay $300 in interest in the primary year. Assuming you paid off $1200 in the main year and just owed $8,800 in year two, your interest for year two would be $264. Your cumulative interest for a really long time one and two would be $564.