Learning how to figure simple interest problems is a valuable math skill with numerous applications in daily life. You can use simple interest to evaluate financial products and determine if you are saving enough money to meet your goals. To illustrate this concept, this article will provide you with the formula and several examples.
How Do You Figure Simple Interest?
You can figure out simple interest math problems using this standard formula:
I = P r t
This formula means that you multiply the principal (p) times the interest rate times (r) the length of the loan (t).
Jones borrows $1000 from Smith for two years at an interest rate of three percent. Jones and Smith agree that the loan will be calculated using simple interest. Jones wants to know how much interest he will have to pay. The answer can be found using the formula stated above:
I = P r t
I= (1000) (0.03) (2)
I = 60
At the end of the two years, Jones will have to pay back $1060 to Smith ($60 interest and $1000 principal).
Practical Application: Borrowing
When a friend, family member or bank lends you money, they are taking a risk that you might not pay back the loan. Interest is a commonly accepted way of compensating lenders for the risk they take in lending. In many cases, borrowing money from a bank may involve compound interest.
Melissa wants to open a small bakery and needs a loan to buy equipment, supplies and to hire staff. Based on her business plan, she thinks the bakery will start to make substantial profits after four years of operation. Melissa asks for a loan from Johan, an old friend, who runs a bakery in a nearby city. In addition to the simple interest loan, they agree to meet monthly to discuss the progress of Melissa’s bakery.
Melissa and Johan agree to the following terms. Johan will loan $100,000 to Melissa for four years at an interest rate of five percent. How much interest will Melissa have to pay at the end of the loan?
I = P r t
I= (100,000) (0.05) (4)
I = 20,000
Melissa will have to pay $20,000 in interest in addition to the principal of the loan, $100,000, at the end of the loan.
The concept of simple interest can also be used to make investment decisions. For example, savings accounts, bonds and certificates of deposits all offer varying interest rates. In this simple interest math problem, Jeff wants to know how much interest he will earn if he puts $1000 of his savings into a savings account with a 3.5% interest rate for a year. In this case, the savings account pays interest once a year using simple interest (savings accounts often provide compound interest).
I = P r t
I=(1000) (0.035) (1)
At the end of a year, Jeff will have earned $35 in interest. After earning this interest, he decides to leave his money in the account for another year.
The references section below shows you further examples on how do you figure simple interest rates and their impact on borrowing, lending and investing.
Image Credit: Wikimedia Commons/FBI Buffalo Field Office
Simple Daily Interest Calculator, https://www.fms.treas.gov/prompt/ppcalc1.html
Simple Interest, https://www.asu.edu/courses/mat142ej/finance/notes/Simple_Interest.html