Math calculations are embedded in our day to day lives and we’ve been calculating since birth…well not birth, but you get the picture. As we mature, so does the type of math we encounter and some of us grow to actually love math. So much so that we seek employment that will allow us to perform mathematical calculations All Day! As you begin to purchase assets and liabilities (i.e. car), make investments, apply for or defer a student loan, etc. it behooves us all to understand and know how to calculate the principal and interest, the balance and amounts due, discounts, and equity.
We live in a society that is intrinsically linked to money and everyone wants their share of the money pie. Interest rates are at the core of the economy, it impacts every area of the financial market including the housing market, stocks, bonds, options, etc. The rise or fall of interest rates determine consumer spending and when consumers spend, the financial markets win. There are some factors that are out of your control, however, it’s still a good idea to know them. [Supply and demand] – If the demand for money decreases or the supply of money increases then interest rates will be lower. If the opposite occurs then interest rates will increase. [Inflation] – When the price for goods and services increase it decreases the purchasing power of money. [Federal rates] – This rate is controlled by the U.S. Federal Reserve or the central bank. In an effort to control inflation, the central bank will determine interest rates. For instance, if the economy is moving slowly then the central bank will lower the federal funds rate, which lowers interest rates to encourage consumers to borrow. If the economy moves too fast then the central bank will raise the federal funds rate, which increases interest rates, to discourage consumer borrowing. Interest rates are applied to the principal balance and is referred to as the “risk fee”. The principal (the amount borrowed or the original amount agreed to pay) will always be plainly shown and explained but the interest is another animal. When applying for a loan do you know if the interest rate is simple, compound, amortized, fixed, variable, prime or discount? Understanding the type of interest rate will help you to make an informed decision, one based on what’s economically feasible for you.
Equity is the remaining value of an asset after liabilities has been subtracted. Often times when people talk about equity they are referring to home equity and this same calculation can be applied (current value of the home minus what you owe). Hopefully the calculation provides a positive number because it represents a gain which can be attributed to paying down the principal and an increased market value. Building equity takes time, it’s a long-term investment but it’s definitely not guaranteed. Homeowners that went through the housing decline know all too well that equity can completely disappear. This tidbit of information is not to deter you but to inform you. So if you’re interested in building your portfolio, building equity is a good way to do it with the understanding that it increases with time.
You receive a billing statement and the statement shows the amount due and the statement balance. You know both amounts mean something but you’re not sure what. Better yet, you’re not sure how much to pay. Both amounts represent what is owed to the creditor but understanding what they mean and how they are applied is useful information in determining payment. The amount due represents the minimum amount that needs to be paid to the creditor. This is a percentage of the total balance owed and it is not the payoff amount. As long as the amount due is paid regularly and on time, the account will remain in good standing with the creditor and there is no negative impact to your credit report. A new balance is calculated by taking the statement balance minus the payments plus additional charges (if any). The statement balance or balance is the sum total amount owed to the creditor. This balance is adjusted each month based on payments and other transactions that have occurred during the statement period. This amount can also serve as the payoff amount meaning if you pay this balance in full, you eliminate future payments to the creditor.
Depending on the context in which the words discount rates are used will decide the definition. In the consumer world it can mean the amount that will be deducted from an item or sale, in the world of accounting and finance it can represent the interest rate charged by the Federal Reserve Bank to commercial banks and financial institutions for loans they received; and it can refer to the interest rate used to determine the net present value of future cash flows in a discounted cash flow analysis. This is not an exhaustive list but these are pretty common. To calculate a discount rate as a consumer of goods or services, one would simply convert the percentage discount rate to a decimal, then multiply this by the original price to get the discount. Then subtract the discount from the original price to get the new selling price. Using the discount rate to determine the net present value is a bit more complex and thankfully using the NPV formula in excel will simplify the calculation but if you’re interested in performing the calculation on your own, the formula is: