How to Calculate Simple Interest

Of all the things you probably learn in your math class, interest is one concept you must pay attention to; it has a lot of applicability in life later on. While it is relatively simpler to calculate simple interest, a few complexities can leave you dumbfounded. Let's understand the concept and then see how to go about working on it.

Suppose, A borrows money from B. In this case, A is charged interest for getting this privilege, and B earns this interest. A is the borrower and B is the lender in this transaction.

Simple interest is charged on the basic amount of money borrowed, called the Principal. Simple interest loans are mostly short-term loans and the interest is calculated in percentage. Simple interest is what the bank pays you on your deposits.

A borrows USD 20,000 from B for a term of 6 years at 5% simple interest.

Here, the P (Principal) = 20,000, R (Rate of Interest) = 5%, and T (Term) = 6.

Note: 5% = 5/100 = 0.05

So, going by our formula of I = P x R x T,

Simple Interest = 20,000 x 0.05 x 6
= 1,20,000 x 0.05
= 6,000

It is not necessary that a particular amount of money is always borrowed for a few years. It can also be borrowed for a few days or some months. However, we do not consider months but only days. Let's have a look at one more example.

A borrows USD 10,000 from B, from February 14, 2011 to August 12, 2011, at 10% simple interest.

Now, the formula is still I = PRT. But the T here will change. Let's see how.

We need to first count the number of days in each month that the money is borrowed for. Here we have,

February = 15, March = 31, April = 30, May = 31, June = 30, July = 31, and August = 12.

. ' . 15 + 31 + 30 + 31 + 30 + 31 + 12 = 180 days.

But in the formula, we will consider, 180/365 as it is 180 days out of 365 days.

So, the end result formula for simple interest will be = 10,000 x 0.10 x 180/365

Simple interest loans are calculated in a similar way. To understand better, let's look at this example.

A woman purchases a designer bag worth USD 10,000. Her interest rate stands at 10% and the time period at 1 year. She also opts for weekly installments.

How much interest will she have to pay?

I = P x R x T
= 10,000 x 0.10 x 1
= USD 1,000

How much will she have to pay back in all?

Principal Amount + Interest

= 10,000 + 1,000
= USD 11,000

How much will she have to pay every week?

Total payments / loan period x no. of weeks in a year.

. ' . 11,000 / 1 x 52
= 11,000 / 52
= USD 211.54

Now that you know how to calculate simple interest, it'll be easier for you to manage your finances in respect to loans and the like.