# Periodic Interest Rate Definition How It Works and Example

## Periodic Interest Rate Definition

A periodic interest rate is a measure of the interest rate that is applied to a loan or investment on a periodic basis, such as monthly or annually. It represents the cost of borrowing or the return on investment over a specific period of time.

The periodic interest rate is typically expressed as a percentage and is used to calculate the amount of interest that will be charged or earned during each period. It is an important factor in determining the overall cost or return of a loan or investment.

For example, if you have a loan with an annual interest rate of 6%, the periodic interest rate would be 0.5% per month (6% divided by 12 months). This means that each month, you would be charged 0.5% of the remaining loan balance as interest.

The periodic interest rate is used in various financial calculations, such as determining the monthly payment on a loan, calculating the interest earned on an investment, or comparing the costs of different loan options. It allows borrowers and investors to understand the true cost or return of their financial transactions.

In summary, the periodic interest rate is a measure of the interest rate applied to a loan or investment on a periodic basis. It is used to calculate the cost or return of the transaction and is an important factor in financial decision-making.

## What is a Periodic Interest Rate?

The periodic interest rate is an important factor in determining the cost of borrowing or the return on investment. It represents the amount of interest that will be charged or earned during each period, such as a month or a year.

For example, if you have a loan with a periodic interest rate of 5% per year, it means that you will be charged 5% of the loan amount as interest for each year. If the loan term is 5 years, you will pay a total of 25% in interest over the course of the loan.

Similarly, if you have an investment with a periodic interest rate of 3% per quarter, it means that you will earn 3% of the investment amount as interest for each quarter. If you hold the investment for 1 year, you will earn a total of 12% in interest.

The periodic interest rate is used to calculate the interest payments or earnings for each period. It is usually applied to the outstanding balance or the initial investment amount at the beginning of each period.

It is important to note that the periodic interest rate may differ from the annual interest rate. The annual interest rate is the rate that is quoted or advertised, while the periodic interest rate is the rate that is actually applied to the loan or investment on a periodic basis.

In summary, the periodic interest rate is the rate at which interest is charged or earned on a loan or investment over a specific period of time. It is expressed as a percentage and is used to calculate the interest payments or earnings for each period.

## How Does a Periodic Interest Rate Work?

A periodic interest rate is a type of interest rate that is applied to a loan or investment on a regular basis, typically monthly or annually. It is calculated based on the principal amount and the annual interest rate. The periodic interest rate is used to determine the amount of interest that will be charged or earned during each period.

When a loan or investment is made, the periodic interest rate is applied to the principal amount to calculate the interest for that period. For example, if the annual interest rate is 5% and the loan is compounded monthly, the periodic interest rate would be 5% divided by 12, or 0.4167% per month.

The periodic interest rate is typically expressed as a decimal or a percentage. It is important to understand the difference between the nominal interest rate and the periodic interest rate. The nominal interest rate is the annual interest rate, while the periodic interest rate is the rate that is applied to each period.

To calculate the interest for a specific period, the periodic interest rate is multiplied by the principal amount. For example, if the principal amount is \$10,000 and the periodic interest rate is 0.4167%, the interest for that period would be \$10,000 multiplied by 0.4167%, or \$41.67.

### Example:

Let’s say you have a loan with a principal amount of \$50,000 and an annual interest rate of 6%. The loan is compounded monthly, so the periodic interest rate would be 6% divided by 12, or 0.5% per month.

At the end of the first month, the interest for that period would be \$50,000 multiplied by 0.5%, or \$250. This interest is added to the principal amount, making the new principal amount \$50,250.

At the end of the second month, the interest for that period would be \$50,250 multiplied by 0.5%, or \$251.25. This interest is added to the principal amount again, making the new principal amount \$50,501.25.

This process continues for each period until the loan is fully paid off. The periodic interest rate allows for the calculation of the interest for each period and helps to determine the total amount of interest paid over the life of the loan.

Period Principal Amount Periodic Interest Rate Interest for the Period New Principal Amount
1 \$50,000 0.5% \$250 \$50,250
2 \$50,250 0.5% \$251.25 \$50,501.25
3 \$50,501.25 0.5% \$252.51 \$50,753.76
4 \$50,753.76 0.5% \$253.77 \$51,007.53
5 \$51,007.53 0.5% \$255.04 \$51,262.57

## Example of a Periodic Interest Rate

Let’s consider an example to better understand how a periodic interest rate works. Suppose you have taken out a loan with an annual interest rate of 10%. The loan term is 2 years, and the interest is compounded monthly.

To calculate the periodic interest rate, you need to divide the annual interest rate by the number of compounding periods in a year. Since the interest is compounded monthly, there are 12 compounding periods in a year. Therefore, the periodic interest rate would be 10% divided by 12, which equals 0.83%.

Now, let’s say you borrowed \$10,000. With a 0.83% monthly interest rate, the interest for the first month would be \$10,000 multiplied by 0.83%, which equals \$83.33. After paying off the interest, your remaining loan balance would be \$10,083.33.

For the second month, the interest would be calculated based on the new loan balance of \$10,083.33. The interest for the second month would be \$10,083.33 multiplied by 0.83%, which equals \$83.57. After paying off the interest, your remaining loan balance would be \$10,166.90.

This process continues for each month until the loan is fully repaid. Each month, the interest is calculated based on the new loan balance, which gradually decreases as you make payments. This is how a periodic interest rate works in practice.