Why study interest formulas?

You’re in the market for a new refrigerator, but don’t have a lot of cash on hand to make the purchase. A flyer from an appliance rent-to-own store arrives in the mail one day, containing a very tempting offer: the refrigerator of your dreams for only $17.99 per week!

The thought of paying $17.99 a week seems reasonable given your current budget, but you hesitate when you read the fine print. The rent-to-own contract specifies that payments must be made for two full years. That’s 104 weeks at $17.99 per week!

At the local big box store, the same refrigerator is listed at only $1299, including all taxes and fees. When you tell your brother about the two deals, he offers to help you buy the refrigerator from the big box store at the lower price of $1299. However he will charge you 20% interest on the full price and wants you to pay off the balance within 12 months. You like the lower price, but 20% seems like a pretty high percentage to pay out to your brother.

Then you discover a third option. The big box store offers a store credit line at 15% APR.  After reading the fine print, you learn that the credit line works just like a loan. The interest will be compounded each month, and there will be a fixed monthly payment for a total of 36 months.  You wonder how much interest will accumulate on the $1299 ticket price of the refrigerator.

Which offer is better? Renting-to-own for two years, buying it on a 20% loan from your brother, or using the store’s line of credit at 15% compounding interest? 

In order to make an informed decision, there are two major factors that you will need to consider: the total cost for each of the three scenarios and the monthly payment for each scenario.

The rent-to-own situation is the easiest to calculate because all of the fees and interest have been figured into the monthly payment already. To determine the total cost, simply multiply the number of weeks in two full years by the weekly payment.

 [latex]104\times17.99=1870.96[/latex]

To find the monthly payment, we divide the total cost by 24 (since it will be paid out over two years = 24 months).

The other two scenarios involve interest formulas. We will revisit this question to see which offer is the best deal after we gain the tools we need to analyze the other two scenarios.

In this module, you will learn how to calculate taxes and two ways to calculate interest; simple and compound. Understanding interest rates and how interest is calculated will help you become a more informed consumer, potentially saving you a lot of money on big purchases such as appliances, cars and even your home.