How to Calculate Simple Interest with Examples
This tutorial explains the meaning and how simple interest is calculated.
Related tutorial: How to calculate compound interest
What is simple interest?
Interest is a fixed percentage of money paid in proportion to the amount and duration of money lent or borrowed. In simple interest, the interest is charged only on the principal amount.
In the simple interest calculation, interest is accrued only on the initial principal each time. In other words, even if the amount of interest accrues and grows beyond the original investment amount, the amount of interest accrued is fixed.
Since government bonds and corporate bonds generally do not have a reinvestment system, they can be classified as simple interest rates. In addition, mutual funds that receive dividends each month without reinvesting are another type of simple interest financial product.
There are two types of time deposits at banks and credit unions: simple interest and compound interest. Depending on which you choose, the conditions for depositing often differ.
How to calculate simple interest
Next, I will show you the formula for calculating interest when choosing a simple interest financial product. First, the formula for calculating interest is as follows:
Interest = Principal x Interest Rate
Interest is accrued on the maturity date specified at the time of deposit. In addition, interest rates are often indicated by the interest rate at the time of deposit for one year.
In other words, if you deposit one year term (0.05%) with a principal of $1,000,000, you will receive $500 ($1,000,000 x 0.0005) in interest after 1 year. if you continue one year term for three years, the total interest can be calculated as interest on maturity date x three years.
The longer the investment period, the more interest you will receive with compound interest than simple interest.
In the case of simple interest, if the annual interest rate is 0.05%, the interest received each year is $500, so the total amount of interest received after three years is $1500.
Let's take a look at another example:
The annual interest rate is 3%, the principal amount is $1,000,000, and 2 years deposit.
Interest rate for the first year = $1,000,000 x 3% = $30,000.
Total principal and interest for the first year = $1,000,000 + $30,000
Interest rate for the second year = $1,000,000 x 3% = $30,000.
Total principal and interest for the second year = $1,003,000 + $30,000
This tutorial explained what simple interest is and how to calculate it with examples.
There are two types of interest calculations for financial instruments: simple interest and compound interest. In simple interest, the amount of interest is constant because the interest is paid on the initial principal, while compound interest is a method of incorporating interest into the principal.
For a financial product that pays interest every year, the investment results in the first year are the same, but there will be a difference after the second year.