When a person lends money to a borrower, the borrower usually has to pay some extra amount of money to the lender. This extra money is called Interest. We express this interest in terms of the amount that borrower takes initially. The money that is borrowed or lent out for a certain period of time is called the Principal or Sum. Interest is usually charged as a percent( per year) of the amount borrowed.
Simple interest is a method of calculating interest charged on fixed deposit, saving account and loan. It is calculated on the principal amount. Simple interest is when interest is charged on the principal amount on daily/monthly/quarterly/annual basis and does not add any interest rate on the interest amount gathered on the principal amount.
Let's understand Simple Interest(S.I) using an example:
John borrows $1000 from a local bank. The bank offers money at 10% interest rate yearly. Of course, after a year John will pay back the principal amount $1000 but along with this amount he will pay interest of $1000 × 10% = 100. So John will pay back $1100 to the bank.
|
Today Loan |
Next Year Repayment |
| Bank ---- Lends ----> John | John ---Repays----> Bank |
|
Lender: Bank Borrower: John Principal: $1000 |
Interest: $100 Repay Amount: $1100 |
If John borrows money for 2 years, the interest levied on the principal is:
Interest in first year + Interest in second year = $100 + $100 = $200 (Simple Interest pays the same amount of interest every year)
Formula :
\(I = P \times R \times T\)
where
Example: If you invest $10,000 in a fixed deposit for a period of 2 years at an interest rate of 5%, then the simple interest earned will be:
\(S.I = \frac{10000 \times 2 \times 5}{100} = 1000\)
You will receive at the end of second year = $1000 + $10,000 = $11000
