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Simple Interest

Simple Interest can be used to determine the present value of a future amount. Simple interest can also be used to determine the future value of a current amount. The simple interest calculator below can be used to determine future value, present value, the period interest rate, and the number of periods.

Simple Interest Definition

Simple Interest is the interest generated on a principal amount that does not compound. Interest generated in one period is not added to principal and charged interest again in the next period.

Variables

FV=Future value of the principal and interest
PV=Present value of principal before interest is applied
K=Interest rate charged per period
T=Number of periods interest is charged
I=Amount of interest charged

 

 

Simple Interest Formula

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Simple Interest


Simple interest is a way of accumulating interest on principal.  When money is borrowed, the borrower is usually required to pay the supplier of the funds a rate of interest until the principal has been repaid.  This is a simple concept to understand, but can have many complex ramifications, depending on how the interest is being calculated.

Simple interest is not compounded.  This means that any interest earned over a period of time will not be added to principal and charged interest again in future periods.  Simple interest accumulates without interest being charged upon it.  This is beneficial for those borrowing money, and can be costly for those lending money while charging simple interest.

Example:  Borrow $1000 for two years, at 10% simple interest annually (at the end of each year).  At the end of the first year, interest of $100 is charged, $100 simple interest is charged in the second year, and every year thereafter.  If this continues, then the amount of interest charged every year will not increase.

Since simple interest is not compounded, the frequency of interest payments or charges will not affect the total amount of interest to be paid.  Charging 1% simple interest every month is the exact same as charging 12% a year, or 60% every five years.

Governments often require financial institutions to disclose information related to simple interest and compound interest directly to its customers.  Often you will see a specific rate of interest declared as the effective annual rate (EAR), or the annual percentage rate (APR), or some derivative of the term.  A 12% annual percentage rate that is compounded monthly, will have an APR of 12.6825%, a higher amount than the rate of interest that is actually charged to the principal at each compounding frequency.

Performing the simple interest calculations is simple and can easily be calculated over longer periods.

It is important to differentiate compound interest from simple interest.  Simple interest is interest that is charged on a principal amount, like compound interest.  The difference is that once simple interest is charged, it is not added to the principal to be charged further interest.  Many bonds work this way.  Interest charged on a bond is often paid as cash, and can only be compounded if the investor who receives the cash payment of the interest finds another investment to invest in.

When simple interest is charged to principal, the rate applied to the principal is called the period rate, or periodic rate of interest.  To determine the period interest rate, simply take the annual rate of interest, and divide it by the number of compounding frequencies in a year.  If 12% interest is compounded quarterly (4 times a year), then the period interest rate is 3% (12%  4). 

Comparing the interest costs with simple interest is very easy, as the higher the rate, the higher the cost of interest over time.  When compound interest is charged this can be more difficult.  Please see our compound interest page to understand how to compare interest costs using compound interest.  Using a powerful loan calculator or mortgage calculator such as the ones provided in this site will help borrowers to understand the actual cost of interest.

The simple interest calculator above on this page will provide you with the answers to many simple interest calculations.  Each variable of the formula is isolated, and defined.  Each simple interest formula is also provided.  When using the simple interest calculator it is important to remember to use the period interest rate, which can differ from the annual interest rate.  Divide the annual interest rate by the number of compounding periods in a year to determine the period interest rate.  You must also input the number of periods that interest will be charged for.  If monthly interest is calculated for 3 years, then simple interest will need to be calculated for 36 periods, at the period interest rate.




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