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Distinguishing between interest and the amount of interest
There is a lot of confusion among the public between interest expressed in percentages and the amount of interest expressed in shekels. We often hear a statement such as: I paid 100 NIS in interest. This is an incorrect statement. It should be said: The amount of interest I paid is 100 NIS.
Interest payment date
For loans up to one year – the interest is paid at the end of the loan period. For loans for more than one year – there are 2 options:
- The interest is paid at the end of each year.
- The actual interest amount is not paid at the end of each year, but the interest is added to the principal from that date, so that the interest in the following year relates to a larger principal.
Example:
My father took out a loan of 1,000 NIS for two years at an interest rate of 8%. The time period “for two years” indicates when my father must repay the principal amount. (Two years from the date of receiving the loan). Regarding the payment of interest, there are 2 options:
- Payment every year end.
- Payment after two years.
Option 1:
In this option, my father will pay 80 NIS for interest at the end of each year. The second payment will be added to the principal repayment.
Option 2:
At the end of two years, my father will pay 166.40 NIS for interest. This payment will be added to the principal repayment.
“Cleverness” in the way the interest amount is calculated
As we will see immediately, over the years, “sophisticated” methods have developed for calculating the amount of interest, which “play” in favor of the lenders. The “sophisticated” methods increase the amount of interest even though they are based on the same interest rate. Each of the calculation methods has a 2-word name, the first word of which is interest. We will review the 4 accepted calculation methods below, which are:
- Nominal interest rate, also known as rate interest .
- Compound interest.
- Adjusted interest rate.
- Effective interest rate.
To some of you, the above paragraph will sound a bit unclear and somewhat unfair, but don’t worry, everything will become clear as we explain each of the types of interest.