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? Better think quickly: your ice cream is melting!
In order to make an informed decision, you will need to know the total cost for all three scenarios. 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. Simply multiply the number of weeks in two full years by the weekly payment.
The other two scenarios involve interest formulas. We will revisit this scenario to see which offer is the best deal after taking a look at the other options.
In this module, you will learn two ways to calculate interest; simple and compound. Understanding interest rates 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.