How to Calculate Implicit Interest Rate

Step-by-Step Guide

1. 1

   Step 1: Define implicit interest.

   If you borrow money from someone and agree to pay it back with an additional amount, you are not specifying any interest or interest rate.
   
   Let's use the example that you borrow $100,000 from your brother and promise to pay him back in 5 years plus an extra $25,000.
   
   In order to find the interest rate that is "implicit" or "implied" in this agreement, you need to do a mathematical calculation.The formula you will use is total amount paid/amount borrowed raised to 1/number of periods = x.
   
   Then x-1 x100 = implicit interest rate.
2. 2

   Step 2: Calculate the implicit interest amount.

   For the example in Step 1, first divide the total payback amount by the borrowed amount.
   
   In this example, you borrowed $100,000 and pay back a total of $125,000, so $125,000 divided by $100,000 is
   1.25., Raise the result of the first step to the power of 1/n, where n is the number of periods interest is paid.
   
   For simplicity, we can use n=5 for 5 years to calculate the implied annual interest rate.
   
   Thus,
   1.25^(1/5) =
   1.25^0.2 =
   1.0456., Subtract 1 from the above result.
   
   Thus
   1.0456-1 =
   0.0456.
   
   Then multiply the above result by 100, to arrive at
   4.56%, which is the implicit interest rate per year.
3. 3

   Step 3: Determine the number of years to repay.

4. 4

   Step 4: Calculate the implied interest percent.

Detailed Guide

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