﻿ Simple Interest

# Simple Interest

## Definition

The term simple interest is used to describe a calculation involving the application of a rate to principal.  Simple interest would be equal to the financing charge associated with the outstanding principal of a loan in one period of time.

### Calculation

Simple Interest = Principal x Rate x Time

### Explanation

Lenders charge borrowers a rate of interest as payment for the use of that money.  The financing charge, or interest charge, is a function of the amount borrowed (outstanding principal), the length of time it is used (time), and the cost to borrow (interest rate).  With an amortizing loan, the borrower repays a lender both the interest charges and principal.

Simple interest is calculated at a point in time, and is usually associated with loans.  Compound interest is typically used by lenders when stating the interest earned on a deposit.  For example, a bank might pay a simple interest rate of 5.000% and apply it daily to an account balance.  This allows the bank to state the rate as 5.127%, compounded daily.

### Example

Lindsey borrows \$1,000 from a family member, promising to repay the money owed in two years.  The family member has agreed to lend her this money but is charging her 10% per year for its use.  Lindsey would owe this family member a simple interest charge of:

= \$1,000 x 10% per year x 2 years
= \$200

The total amount repaid would be:

= \$1,000 (in principal) + \$200 (simple interest), or \$1,200