What Is Simple Interest and How Does It Work?
When it comes to mastering your finances, it’s important to understand simple interest. While you could use an interest calculator, the math involved is not complex. Once you understand how interest works, you can make better-informed financial decisions.
Guide to Simple Interest
A basic simple interest definition is the money paid on a loan or money earned on a deposit.
For instance, when you borrow money, you must repay not only the amount you borrowed – the principal – but also an extra percentage of the principal, known as interest. Likewise, if you deposit money into a savings account, you will earn money on the initial deposit, which is also interest. Unlike compound interest where the amount of interest is calculated based on principal and earned interest, the amount of simple interest you pay or earn is calculated based on the original principal amount.
Simple Interest Formula
You can use the formula below to calculate simple interest:
I = P x r x t
Calculate simple interest (I) by multiplying the principal (p) by the rate (r) by the number of time periods (t).
Here’s a quick example of the interest you’d earn on a one-year $500 investment that yields 5% interest.
$500 x 5% x 1 year = $25
As you can see, calculating simple interest is, well… simple. If you prefer, you can always use our simple interest calculator to ensure your numbers are correct. Another option would be to use an Excel spreadsheet to assist you with your calculations.