Simple Interest Explained

Simple interest is a quick and easy method of calculating the interest charge on a loan or investment. It is calculated only on the principal amount, or on that portion of the principal amount that remains unpaid.

How Simple Interest is Calculated

Simple interest is determined by multiplying the daily interest rate by the principal by the number of days that elapse between payments. This type of interest usually applies to automobile loans or short-term personal loans. It can also be used to calculate the interest on a mortgage payment.

The Simple Interest Formula

The formula for calculating simple interest is:

Simple Interest = P x I x N

Where:

• P = Principal amount (the original amount of money)
• I = Interest rate (annual rate, expressed as a decimal)
• N = Number of periods (the loan or investment duration in years)

Step-by-Step Example

Let's say you borrow $10,000 from a bank at an annual interest rate of 5% for 3 years.

1. Identify the variables:
   • P = $10,000
   • I = 5% or 0.05 (as a decimal)
   • N = 3 years
2. Apply the formula:
   • Simple Interest = P x I x N
   • Simple Interest = $10,000 x 0.05 x 3
3. Calculate the result:
   • Simple Interest = $1,500

So, the total simple interest you would pay over 3 years is $1,500.