Periodic Rate

What Is A Periodic Rate?

The periodic rate is the interest rate charged over a certain number of periods, and it equals the annual interest rate divided by the number of periods. The periodic rate, also known as the periodic interest rate, can be charged on a loan or realized on an investment over a specific period.

Deeper Definition

The interest on mortgage compounds or applies every month. If the annual interest rate on that mortgage is 6%, the periodic interest rate used to calculate the interest assessed in any single month is 0.06 divided by 12, working out to 0.006.

Assuming a financial institution charges periodic interest based on the average balance monthly or daily, the effective interest rate is higher than the stated annual interest rate. The reason is compounding interest, and the impact of the periodic rate exacerbates when interest rates are high. For example, if the variable interest rate on a credit card is 13 percent, the daily interest rate would be 0.036 percent.

Credit card issuers may calculate the interest rate a borrower pays on their credit card as part of their monthly bill daily. Credit card issuers convert the APR to a daily rate using the following math equation:  Annual Percentage Rate (APR) ÷ 365 (number of days in the year).

The periodic rate determines how much interest a borrower will owe or pay each compounding period. For example, knowing the periodic rate for a credit card helps borrowers compute how much interest they will pay if they carry a balance for a month. Alternatively, if one has money in a savings account, one can calculate how much interest one will earn for the month.

Periodic Rate Example

It is common knowledge that commercial banks usually require collateral when giving out loans. These collaterals, if the loan beneficiary refuses to pay, can be confiscated to offset the debt. However, credit card issuers are not so lucky as no collateral is needed to issue a card. Consequently, the only option for card issuers not to run at a high loss is to charge a relatively high periodic interest on the cards to recover their capital quickly. For instance, a credit card issuer charges 15 percent interest annually but deducts the amount in the monthly bill sent to borrowers.