Interest paid on a loan is calculated as a percentage of the:

• A. monthly payment
• B. future value of the loan
• C. total interest accrued
• D. principal amount

Answer: (D)

Verified step by step guidance

1. Understand the concept of 'principal amount': In financial accounting, the principal amount refers to the original sum of money borrowed or invested, excluding any interest or additional fees.
2. Recognize the formula for calculating interest: Interest is typically calculated using the formula \( I = P \times r \times t \), where \( I \) is the interest, \( P \) is the principal amount, \( r \) is the interest rate, and \( t \) is the time period.
3. Clarify why the principal amount is used: The interest paid on a loan is calculated based on the principal amount because it represents the base amount on which the interest rate is applied. Monthly payments, future value, or total interest accrued are not directly used in this calculation.
4. Relate this to practical scenarios: For example, if you borrow \$10,000 at an annual interest rate of 5%, the interest for one year would be calculated as \( I = 10,000 \times 0.05 \times 1 \). This calculation uses the principal amount (\$10,000) as the base.
5. Summarize the key takeaway: Always remember that the principal amount is the foundation for calculating interest, as it represents the original loan amount before any interest or payments are applied.