What’s The Difference Between Interest Rate and Interest Payment?
There is a great confusion among the public between interest, which is expressed in percentages, and the amount of interest, which is expressed in USD. We frequently hear people say things like, “I paid $100 interest”. This is an incorrect expression. We should say, “The amount of interest I paid was $100”.
Date of the Interest Payment
For loans of one year or less, interest is paid at the end of the duration of the loan. For loans of more than one year, there are two possibilities:
The interest is paid at the end of each year.
The amount of interest is not paid at the end of each year, but the interest from that period is added to the principal, so that the interest in the following year applies to a larger principal.
George takes out a loan of $1,000 for two years at 8% nominal interest (this term will be explained later). The time period, “for two years”, indicates when George will have to return the amount of the principal (two years after receiving the loan). As for payment of the interest, there are two possibilities:
Payment at the end of each year.
- Payment at the end of two years.
Possibility no. 1: According to this possibility, George will pay $80 for the interest at the end of each year. The second payment will be in addition to return on the principal.
Possibility no. 2: George will pay $166.40 in interest at the end of two years. This payment will be in addition to return on the principal.