Simple Interest
Simple interest is a method of calculating the interest charge on a loan or amount of money that is borrowed or invested. Unlike compound interest, where interest is calculated on the initial principal, which also includes all of the accumulated interest from previous periods, simple interest is calculated only on the principal amount or on that portion of the principal amount which remains unpaid.
The formula for simple interest is:
Simple Interest (SI) = P × r × t
Where:
- P is the principal amount (the initial amount of money).
- r is the rate of interest per period (often expressed as an annual rate, so if it’s given as a percentage, you’d divide by 100 to convert it to a decimal form).
- t is the time the money is borrowed or invested for, in years.
Example of Simple Interest
Let’s delve into a more detailed example to illustrate the concept of simple interest.
Scenario: Saving for a Bicycle
Lucy wants to buy a new bicycle that costs $500. Unfortunately, she doesn’t have enough money right now. She approaches her older brother, Tom, to lend her the money. Tom agrees but decides to charge her a simple interest rate of 4% per annum. Lucy promises to repay him in 2 years.
Let’s calculate how much interest Lucy will owe Tom at the end of the 2-year period, using the simple interest formula:
Given:
- Principal amount, P = $500
- Rate of interest, r = 4% or 0.04 (as a decimal)
- Time, t = 2 years
Using the formula:
Simple Interest (SI) = P × r × t
SI = $500 x 0.04 x 2
SI = $40
So, the simple interest accrued over the 2-year period is $40.
Now, to find out the total amount Lucy will have to repay Tom:
Total Amount = Principal + Simple Interest
Total Amount = $500 + $40
Total Amount = $540
After 2 years, Lucy will repay Tom a total of $540, which includes the original amount borrowed and the interest accrued.
This example illustrates how simple interest can be applied in real-life situations, such as lending money to a family member. The interest amount remains the same each year, as it’s calculated only on the initial borrowed or invested amount.
