If you've ever borrowed or lent money, you've probably dealt with interest: An extra fee that you pay when you borrow money or that you charge if someone else owes you money. Interest is expressed as a percentage. For example, a store might charge 4 percent interest to finance an appliance that costs $1,000. Interest can be assessed as simple interest or compound interest. If you're dealing with simple interest, that means the interest fees are calculated based only on the amount of the original investment, debt or loan, which is called the principal.
TL;DR (Too Long; Didn't Read)
The formula for calculating simple interest is principal × interest rate × time. The interest rate should be expressed as a decimal.
Key Terms for Understanding Simple Interest
Before you start calculating simple interest, you need to understand the terms used to describe it. The principal isn't just the boss of a school. Principal also means the amount originally borrowed, loaned or invested. The interest rate tells you what percentage of interest is assessed per time period. For example, a bank might charge 5 percent interest per year. If no time period is given, the interest is usually – but not always – understood to be yearly. And finally, the time period is how long you'll take to pay back the loan, collect the debt or let the investment mature.
The units of measure for the time period should be the same as the unit of time for the interest rate. So if your interest rate is yearly, you'll calculate simple interest in terms of years, too.
Are you looking at a real life loan? Always read the fine print: First to make sure that you're looking at a loan based on simple interest instead of compound interest. Second, to see if there are any penalties for paying the loan off early. If there is no penalty for early payoff, you can pay less interest by paying off the loan sooner than the original payment terms.
Divide the interest rate by 100 to convert it from a percentage to a decimal. So if you took out a consumer loan at a 6 percent interest rate (per year), you'd have:
6 ÷ 100 = .06
If this was already done for you, you can skip straight to Step 2.
Multiply the principal amount of your loan, investment or debt by the decimal form of the interest rate. So if the consumer loan you borrowed at 6 percent interest was for $2,400, you'd have:
$2400 × .06 = $144
This is the amount of interest you'd pay for one time period – in this case, one year. But what if you arranged with the bank that you could take three years to pay the loan back? If you want to know how much total interest you'll pay, you have to include the three years in your calculation.
Multiply the result from Step 2 by the time period of the loan. The result is the amount of interest you'll pay over that time period. So if you get those three years to pay back the loan of $2,400, you'll actually pay the following:
$144 × 3 = $432
About the Author
Lisa studied mathematics at the University of Alaska, Anchorage, and spent several years tutoring high school and university students through scary -- but fun! -- math subjects like algebra and calculus.