How to Calculate Interest Rate with Excel's RATE Function (Easy-to-Follow Guide)
In this article, you will learn how to calculate interest rates by using the Excel RATE function.
What is the RATE function in Excel?
The RATE function in Excel is a financial function that calculates the interest rate per period of a loan or an investment. Understanding and using the RATE function is helpful for financial analysis, as it allows individuals and businesses to better comprehend the financial aspects of loans and investments with periodic payments.
When is it helpful to use the RATE function in Excel?
The RATE function in Excel is extremely helpful in several scenarios, including:
- Investment Assessment: If you're an investor considering different investment opportunities that offer periodic returns, the RATE function can help you calculate the interest rate for these returns. This allows you to compare and decide which investment is likely to be the most profitable.
- Financial Planning: In personal or business financial planning, understanding the rate of return on investments or the interest rate on debts is crucial for long-term planning. The RATE function can help calculate these values so you can make the best financial decisions.
- Debt Repayment Plan: If you're developing a plan to pay off your debts, understanding the interest rate you're being charged is important. The RATE function can help you calculate this rate, which can then inform your repayment strategy.
In general, the RATE function in Excel is a powerful tool that can be used anytime you need to understand the periodic interest rate associated with a series of payments. This can be beneficial for a wide range of financial decisions and analyses.
Understanding the syntax of the Excel RATE function
The syntax of the RATE function in Excel is the following:
nper: The total number of payment periods.
pmt: The payment made each period. This payment should normally include both the principal and the interest, and it must stay constant.
pv: The present value or the total amount that a series of future payments is worth currently. In the context of a loan, this would typically be the principal amount.
fv (optional): The future value or the desired balance after the last payment has been made. If this argument is omitted, the default value is 0, meaning that the loan is expected to be paid off in full over the defined period.
type (optional): This argument determines when the payments are due.
- Input 0 if payments are due at the end of the period (this is the default setting).
- Input 1 if payments are due at the beginning of the period.
guess (optional): Your guess for what you believe the interest rate might be. If omitted, Excel defaults to 10%. The RATE function uses an iterative technique for calculating the rate, so providing a good guess might make the function converge faster.
How to use the RATE function in Excel
Let's consider a scenario where we are comparing three different loans. Each of these loans has the same principal amount ($10,000), but different monthly payments and loan durations. We want to compare these loans based on their monthly interest rates. We can use the RATE function in Excel to calculate the monthly interest rate for each loan. This example is seen in the image below.
And so looking at the first formula we can get a look at how we can use the RATE function. For the nper argument, we input 60 as our number of payment periods in terms of months. Then for the pmt argument, we input our monthly payment of 200. It’s important to note that we put a negative sign in front of the 200 since we are talking about repayments.
As for the pv argument, the current worth of the loan, we input 10000. From there you can also input the optional arguments. For instance, you may want to specify if the payments are due at the beginning of the payment period instead of the default setting of the end of the period.
Note: The RATE function returns the interest rate per period, in this case monthly. However, if you also wanted to know the Annual rate, simply multiply the monthly rate by 12 and convert it to a percentage if needed. This be seen in the image above.
By using the RATE function in this manner, you can determine which loan has the lowest monthly interest rate and is therefore the most cost-effective option and make a more informed decision. This is just one situation in which the RATE function can be used.
All in all, the RATE function is a valuable tool in Excel that offers insights into the financial parameters of loans and investments. Its ability to calculate the periodic interest rate makes it a staple in financial modeling and analysis. Learning how to use it effectively can significantly enhance your capacity to make informed financial decisions.
Go to the page LiveFlow‘s How to Guides to find more information about Excel and Google Sheets formulas and tips that were not covered here.
