# Interest Rate calculation question for math types

Let’s say I want to borrow \$7,000 from a friend. The full \$7,000 balance will be due in 5 years (60 months) but, meanwhile, the monthly payments will be interest only during the 5 year term with a lump sum of \$7,000 due at the end of the five-year term. The monthly interest-only payments will be \$50 per month.

Does this make sense?

What’s the interest rate?

\$50 out of \$7000 is an interest rate of 0.714% per month, or 8.57% per year. The precise value might vary slightly depending on how you’re accounting for compounding, but at less than 1% over the term in which payments are made, that should make almost no difference.

There are other factors than the interest rate to consider, though. For instance, with a loan from the bank, if you manage to scrape together more than the planned payment, that’ll reduce your principle, and hence your next interest payments. If you get a windfall and pay your friend \$750 one month instead of the agreed-upon \$50, will he reduce your interest payments to \$45 a month (keeping the same interest rate)?

\$50/month on \$7000? - easier to calculate because no declining balance.
\$50x12=\$600/yr on \$7000; or ((600/7000)x100)% or 8.57142857142857142857142857… percent.

“Interest is 8.57143 percent per annum rate, paid monthly.” Compounding doesn’t count unless you want tocalculate a weekly or daily rate. As laid out, you are paying each amount as due, and therefore no balance accumulates (or declines).

Now, how that compares with a regular loan where you pay the whole lot in small payments is a whole disssertation. It depends how you value keeping the full principal until the final due date.

Good question. I guess it would make sense to reduce the monthly payment if the principal drops.

Oh, and unless the last payment is \$7050 the borrower is getting a slight break.

So, if I borrow the money on 2/1/10 and the first \$50 payment is due on 3/1/10, then the final payment of \$50 will be due on 2/1/15 along with the \$7000 principal balance. Right?

Yep. you’re renting the money by the month, “rent” payment due at the end of each month you have it. Last rent payment due the day you return it.