In general, there are two formulas that banks use to calculate interest, in regards to investments like real estate. These are known as:

- Simple Interest

- Compound Interest

Simple interest is probably something that you are already familiar with. The basic formula describes that a PRINCIPAL amount of money will accumulate interest at a specific RATE over a specific amount of TIME. Therefore the equation or formula looks like this:

I = (P * r * t) - P

This is formula works for all simple interest equations and can work for most standard investments or loans. One example might be:

$5,000.00 at 8% for 6 years

I = {(5,000) * (0.08) * (6)} - 5,000

I = $2400 total over the course of the investment or loan. (Obviously, if you remove the "6” years from the equation you can calculate the amount of interest accrued over the course of a single year, which in this case would be $400)

Compound interest is a little more complicated. This is the type of formula used to calculate long term investments and it looks like this:

I = {P(1 + r)t} - P

This formula describes that instead of simple interest over a period time, you accrue more interest on top of what you have already earned. So using the same example:

$5,000.00 at 8% for 6 years

I = {5,000(1 + .0.08)6} - 5,000

I = $2934.37

As you can see, compound interest will always earn more, especially the longer the investment sits.

There is a second part to this question which pertains to how banks calculate how much interest to charge. There are two parts to this answer:

1. The prime rate: An average rate based on market stability and availability of funds

2. Your credit history and credit score

Banks use the Prime Rate (1) to set up a scale by which they assess your interest rate based on your credit history (2).

- Simple Interest

- Compound Interest

Simple interest is probably something that you are already familiar with. The basic formula describes that a PRINCIPAL amount of money will accumulate interest at a specific RATE over a specific amount of TIME. Therefore the equation or formula looks like this:

I = (P * r * t) - P

This is formula works for all simple interest equations and can work for most standard investments or loans. One example might be:

$5,000.00 at 8% for 6 years

I = {(5,000) * (0.08) * (6)} - 5,000

I = $2400 total over the course of the investment or loan. (Obviously, if you remove the "6” years from the equation you can calculate the amount of interest accrued over the course of a single year, which in this case would be $400)

Compound interest is a little more complicated. This is the type of formula used to calculate long term investments and it looks like this:

I = {P(1 + r)t} - P

This formula describes that instead of simple interest over a period time, you accrue more interest on top of what you have already earned. So using the same example:

$5,000.00 at 8% for 6 years

I = {5,000(1 + .0.08)6} - 5,000

I = $2934.37

As you can see, compound interest will always earn more, especially the longer the investment sits.

There is a second part to this question which pertains to how banks calculate how much interest to charge. There are two parts to this answer:

1. The prime rate: An average rate based on market stability and availability of funds

2. Your credit history and credit score

Banks use the Prime Rate (1) to set up a scale by which they assess your interest rate based on your credit history (2).