How are Bank and CD Interest Rates calculated

We have always invested money in banks and got best CD Interest Rates from there. We have also taken loans repaid the loan along with interest to the bank. Have we ever wondered how banks calculate the interest that they charge on a loan or calculate the interest which is given to the customers.

Although it is not necessary to know the formula or all the parameters used to calculate interest by banks yet understanding two basic principles may change your way of banking as it would be much easier to judge how to gain more interest out of your savings account or CD or how to pay less interest on the loan that has been lended by a bank to you.

There are two principles that govern the Bank Rates Interest that you pay to your bank or the bank pays you

1) Time
2) Risk involved

The longer you keep the banks money with you in the form of a loan the more interest you will be paying to the bank. Thus a longer loan term means larger amount of money going towards the interest part and the shorter the loan term less money will go to the interest part.

Same principal is followed when you lend money to the bank in the form of a savings account or a CD. More you keep the money in the savings account or CD more interest will be paid by the bank to you.

The risk factor plays an important role while applying for a loan. Very good credit score of the customer means less risk and less interest. A not so good credit score means more risk and more interest.

If observed closely banks have almost same interest for their customers in savings accounts or CD rates yet many people end up earning more interest just because they play with the time factor.

While applying for a loan make sure you keep a tab on your credit scores settle all previous issues with financial institutions and if possible opt for the shortest loan term.

This will not only help you in saving a few extra dollars but will also add up in your fortune as small savings can make up big amounts with time and a good rate of interest.

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