Total annualised interest expenditure is divided by average interest-bearing deposits, other interest-bearing borrowings, and interest-free deposits to determine the cost of funds. This equation does not incorporate capital, despite the fact that many financial institutions include capital when calculating assets.
The term “cost of funds” refers to the interest rate that financial organisations pay on the funds they use for their business. When financial institutions have a lower cost of capital, they can provide consumers with cheaper short-term and long-term interest rates.
Generally, when a customer refers to the cost of funds, they are referring to the genuine cost of a loan. A simple loan calculator, such as the one available on Bankrate.com, can then quickly give consumers with an estimate of the entire cost of a loan. The entire cost of a loan consists of the loan amount (known as the principal) plus any accumulated interest that will be paid if the loan is held to maturity. The formula for determining the simple interest cost of a loan is I = Prt, where I (the total interest on the loan) equals the Principal multiplied by the interest rate multiplied by the loan’s term.
For instance, if $25,000 were to be borrowed at 6% for five years, the following formula would apply:
I = Prt
I = $25,000 x 0.06 x 5
I = $7,500
The entire loan amount is calculated by adding the initial principal amount ($25,000) to the total interest amount ($7,500). This amount ($32,500) represents the total cost of the loan. When calculating compound interest, it is best to consult a financial expert to confirm that the numbers are accurate.
