Simple interest is a straightforward method of calculating interest on money. It is based only on the original principal amount, which means the interest earned each period remains constant. Unlike compound interest, simple interest does not earn interest on previously earned interest, making it easier to calculate and understand.
The simple interest formula is S I equals P times R times T. Here, S I represents the simple interest earned or paid. P is the principal, which is the initial amount of money. R is the annual interest rate expressed as a decimal. And T is the time period in years. This formula makes it easy to calculate exactly how much interest will be earned or paid over any given time period.
Let's work through a simple interest example. You invest one thousand dollars at five percent annual interest for three years. How much simple interest will you earn? First, we identify our values: P equals one thousand dollars, R equals five percent or zero point zero five as a decimal, and T equals three years. Using the formula S I equals P times R times T, we calculate: one thousand times zero point zero five times three equals one hundred fifty dollars in simple interest.
It's important to understand the difference between simple and compound interest. With simple interest, the interest is calculated only on the original principal amount, resulting in the same interest payment each period and linear growth. Compound interest, however, calculates interest on both the principal and previously earned interest, leading to increasing interest amounts each period and exponential growth. This graph shows how compound interest grows faster over time compared to simple interest.
To summarize what we've learned about simple interest: Simple interest is calculated only on the principal amount using the formula S I equals P times R times T. The interest remains constant each period, creating a linear growth pattern. It's easier to calculate than compound interest and is commonly used in basic loans and short-term investments. Understanding simple interest is fundamental for making informed financial decisions.