Simple interest - Financial definition
Concise definition of the term simple interest
Simple interest is a method of interest calculation where no compounding takes place, meaning that due interest is not bearing any interest.
Comprehensive definition of the term simple interest
When calculating with simple interest, it is important to note that the principal amount remains constant throughout the duration of the loan or investment. Subsequently interest payments also remain identical for each period and do not fluctuate over time.
The formula for calculating interest payments using simple interest is:
I=P · r · t
Where:
- I is the interest amount
- P is the principal amount (the initial amount of money)
- r is the interest rate per period (expressed as a decimal)
- t is the time (in years) the money is borrowed or invested
Here's a calculation example:
Suppose you have a principal amount (P) of 10,000 invested at an annual simple interest rate (r) of 5% for 3 years (t). Using the formula above, substitute the values:
I=10,000 · 0.05 · 3
Now, calculate:
I=1,500
So, for an investment of 10,000 over 3 years at a 5% annual simple interest rate, interest earned would be 1,500.