Simple interest is a method of calculating interest in which the interest amount is based solely on the original principal, without considering any accumulated interest over time.
In other words, interest is calculated only once on the principal amount and remains constant throughout the period. This means that the total amount grows linearly, without an exponential growth effect as in compound interest.
The formula used to calculate simple interest in an investment or loan is:
I = P * r * t
Where:
This formula assumes that interest is constant over time and is not reinvested or accumulated, which is what differentiates simple interest from compound interest.
To calculate simple interest, simply use the formula above: I = P * r * t
This formula allows you to determine the amount of interest that will be added to the principal over a given period.
Below is a practical example of how simple interest works:
Suppose you invest $10,000 at an annual interest rate of 10%. Let’s calculate the interest accumulated over 3 years.
Substituting the values:
Interest = 10,000.00 * 0.10 * 3
Interest = 3,000.00
Thus, the total amount after 3 years would be $13,000, with a principal of $10,000 and $3,000 in interest.
To calculate the final amount, simply add the interest to the principal:
Total Amount = Principal + Interest
Total Amount = 10,000.00 + 3,000.00
Total Amount = 13,000.00
Thus, the total amount after 3 years would be $13,000, with a principal of $10,000 and $3,000 in interest.
Fun fact: Under the same conditions, if compound interest were applied, the final amount would be $13,310. This is why banks and investors generally prefer compound interest for long-term growth.
Below is a complete breakdown showing how your investment grows over time:
| Year | Interest | Total Invested | Total Interest | Total Accumulated |
|---|---|---|---|---|
| 0 | -- | 10,000.00 | -- | 10,000.00 |
| 1 | 1,000.00 | 10,000.00 | 1,000.00 | 11,000.00 |
| 2 | 1,000.00 | 10,000.00 | 2,000.00 | 12,000.00 |
| 3 | 1,000.00 | 10,000.00 | 3,000.00 | 13,000.00 |
The main difference between simple interest and compound interest lies in how interest is calculated over time.
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