Common Financial Terms & Concepts

What is Simple Interest? Meaning, Formula & Calculation

Every borrower should know simple interest. Or every accounting and finance savvy person must be aware of this basic terminology. And, we are here to explain what it is. So, know the meaning of simple interest, formula, go through easy examples and learn how we calculate it.

What is Simple Interest?

Simple interest is an effortless method of calculating the interest for a loan. It is a concept which is used in the majority of the sectors such as automation, finance, banking, and so on. When you make a repayment for loan, primarily it goes to the monthly interest and then the remaining will go towards the principal.

In the form of loans, we often need to borrow money from the banks. During the payback, excepting from the principal amount, we have to pay some more money to the bank that relies upon the principal amount as well as the ideal time for which we borrow. This is known as simple interest and this term finds comprehensive utilization in the banking sector. 

Simple Interest: The Real Meaning

In real terms, simple interest is a charge which we have to pay on a principal or income we earn on deposits. 

1. When You Borrow Money:

You have to pay back the principal amount with interest that you borrowed. For interest, you have to make additional payments, which means the cost of borrowing. 

2. When You Lend Money:

Now when you lend money to someone, you commonly set a fixed rate and gain income on interest in exchange for making your money accessible to other people. 

3. When You Deposit Money:

Your savings account always pays you interest as an income since you are making cash accessible to the banks to lend money to other people. 

Simple Interest Basic Concepts 

Principal (P): Principal is the original sum of money deposited or taken as loan. Also known as Capital.

Interest (I): Interest is the amount of money that you earn on a deposit or the amount of money that you pay to borrow money.

Time (T): Time is the duration for which the money is deposited or borrowed.

Rate of Interest (R): The percentage of interest that you earn for money deposited or pay for money you borrowed. 

Simple Interest Formula

If the principal (borrowed money), rate of interest and time periods are given then with the help of a simple interest formula we can easily find the interest amount.

Formula: SI = (P × R ×T)

Where, Simple Interest = SI

Principal = P (Original amount)

Rate of Interest = R (in percentage) 

Time Duration = T (in years)

Let's understand it this way, you can use the above formula to calculate Principal, Time, Interest, and Total amount as well. Simple, Mathematics you know:

For, Calculating Principal Amount: {100×(Simple Interest)}/(Rate × Time)

Calculating Time: {100×(Simple Interest)}/Principal × Rate

Calculating Total Amount: Amount (A) = Principal (P) + Interest (I)

Simple Interest Examples

Here are some easy to grasp examples of simple interest calculation:

Example 1:

Let's say Mansi borrowed Rs. 50,000 for 3 years at a rate of 3.5% per annum. Now, let's find the interest paid by her at the end of 3 years.

Here, Principal = Rs. 50,000/-

Interest Rate = 3.5%

Time = 3 years

Simple Interest = (P × R ×T) / 100 = (50,000× 3.5 ×3) / 100 = 5250

Interest paid = Rs. 5250/-  

Example 2:

How much time it will take for an amount of Rs. 900 to submit Rs. 81 as simple interest, at the rate of 4.5% per annum?

Here, {100×(Simple Interest)}/Principal × Rate

T= 100 × Simple Interest / P*R = 100 × 81 / 900 × 4.5 = 2

Time = 2 years 

Example 3:

Let's say, Rajeev borrowed Rs. 60 and at the end of four months he paid Rs. 66. How we we'll calculate the interest rate per annum in this scenario?

Remember the formula

Here, Interest rate per annum = 66 - 60 = 6

Therefore, 6 = 60/100 × R × 4/12 = 30%

Answer: Interest Rate = 30%

So, this was some important information on one of the simplest concept in accounting and finance i.e. Simple Interest. Of course, very simple to memorize and implement.

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