Author Topic: Comparing interest rates: please help me calculate!  (Read 1553 times)

Spruit

  • Handlebar Stache
  • *****
  • Posts: 1203
  • Location: Netherlands
Comparing interest rates: please help me calculate!
« on: February 18, 2015, 01:07:27 PM »
Hi guys! I'm not a native speaker and no numbers wizz so please bear with me as I try to clarify my problem...
Short version: how to calculate the "true" yearly interest rate of a loan which includes monthly interest-on-interest effect vs. savingsaccount that only includes interest on a once-a-year basis?

Long version: I recently discovered that my student loan's interest rate is calculated differently than the interest I receive on my savings account. SL's interest: 0.81%, savings interest: 1.30%. That seemed like a relatively profitable interest difference. But.... the interest on the SLs is added to the principal every month (when no payment is done). The given rate of 0.81% is the annual interest rate (luckily). However, because of the interest-on-interest effect of the loan calculation, the effective annual interest might exceed the annual interest I receive on the savings account.

To determine the right course of action,  I'd like to calculate whether it's wiser to save up the SL money and keep it in the savings account for as long as possible, or if I'd better pay it back as soon as possible if the current situation is costing me extra every month.
I have some excell skills (IF functions, basic calculations and statistics), however I'm not experienced with the financial formulas enough for this. I know there are excell experts out there for whom this is child's play. I'd really like to discover this stuff, so.... please help me learn to run the numbers myself. Any tips or tricks are very welcome. I hope I made the issue clear enough for you to do so, but if not than please let me know so I can elaborate!
Thanks in advance!

johnstein

  • 5 O'Clock Shadow
  • *
  • Posts: 20
  • Location: Houston, TX
Re: Comparing interest rates: please help me calculate!
« Reply #1 on: February 18, 2015, 02:41:00 PM »
Not sure what's the methodology in your country, but here in the US, typical student loans are compounded daily and the savings account interest are calculated based on the average balance of the month x the interest amount.  Read the fine print.

It may be easier to get a daily interest charge on both accounts and see what's the differences are and scale up from there. 

dandarc

  • Magnum Stache
  • ******
  • Posts: 3468
  • Age: 36
Re: Comparing interest rates: please help me calculate!
« Reply #2 on: February 18, 2015, 02:45:37 PM »
(1 + .0081 / 12) ^ 12 - 1 = .00813 = .813% APY for your student loan.

Crazy low rates make monthly or daily compounding less of an issue than it could otherwise be.

dandarc

  • Magnum Stache
  • ******
  • Posts: 3468
  • Age: 36
Re: Comparing interest rates: please help me calculate!
« Reply #3 on: February 18, 2015, 02:51:13 PM »
One other thing to consider - taxes.  If your 1.3% annual compounded savings account is taxed at 50%, it is only yielding 0.65% after tax.

Of course student loan interest could be exempt from taxes (often is in US).

Spruit

  • Handlebar Stache
  • *****
  • Posts: 1203
  • Location: Netherlands
Re: Comparing interest rates: please help me calculate!
« Reply #4 on: February 18, 2015, 05:09:03 PM »
(1 + .0081 / 12) ^ 12 - 1 = .00813 = .813% APY for your student loan.

Crazy low rates make monthly or daily compounding less of an issue than it could otherwise be.

Oh wow, that is not so bad. Still worth it to postpone payback based on annual interest in this case. Tax isn't an issue as the debt itself is indeed exempt. The interest is not, but that amount doesn't exceed the capital tax threshold for several years to come.
So, it looks for now that holding onto the borrowed money is still reasonable. Thanks for the help everyone! Big relief for now :-)