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What Is Simple Interest?
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Before any calculations with interest are carried out, you have to present interest as a
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Hi, Zoya Popova for About.com, and today going to talk about simple interest.But first off – what is interest? Interest is a compensation which is paid by somebody who borrowed financial assets to the person that owns those financial assets. When you borrow money and use it over a period of time, you're expected to pay back the sum of money that you borrowed, which is called the principal, as well as a compensation for using that money, which is called the interest.The most common way to express interest is through percentages. Percentages are basically a type of fraction that have 100 as their denominator. For example, 10% means 10/100, and 45% means 45/100. It is important to keep in mind that, before any calculations with interest are carried out, you have to present interest as a decimal number.To make the conversion faster, simply take the percentage notation and move the decimal point 2 places to the left. Most commonly, interest rates are expressed on an annual basis. For example, if you borrow $500 at 10% per year, at the end of the year you will have to pay 0.10 times 500 in interest:P = 500r = 10% = 0.10I = 0.10 x 500 = 50But what happens if you use that money for more than 1 year, 2 or 3 years, let's say? Well, this is where the concept of simple interest comes into play. Unlike compound interest, simple interest is only calculated on the amount of the principle, in our case, $500.In the first year, the interest will amount to 0.10x$500, or $50. In the second year, we will again multiply our annual interest rate by the principle, and get $50 again. The same holds true for the third year. As a result, we can come up with a formula for simple interest.Simple interest equals the principal multiplied by the interest rate multiplied by the time period. In our case, P = 500r = 0.10t = 3I = Prt = 500 x 0.10 x 3 = 150.One thing to keep in mind while calculating simple interest is that your time period and your interest rate should match.For example, if you're trying to calculate how much you will pay over a period of 6 months, and your interest rate is expressed on an annual basis, such as here: P = 3000r = 4.5% = 0.045 per year t = 6 months, you cannot simply multiply 3000x0.045 by the number of months. Instead, you must present those 6 months as a portion of the year. I = 3000 x 0.045 x 6/12 = 67.5.6 is presented as a portion of 12, because because there are 12 months in a year. And this is it for simple interest.Thank you for watching, and for more information, please visit us on the web at About.com.
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