How Simple Interest Works

What is Simple Interest and how does it differ from Compound Interest? Simple Interest is a method of calculating interest on a principal amount of a loan or deposit. Unlike Compound Interest, which takes into account the accumulated interest over time, Simple Interest is calculated only on the original principal amount.

Definition of Simple Interest

Simple Interest is a type of interest calculation method that applies a fixed percentage rate to the original principal amount of a loan or deposit. This means that the interest is calculated only on the initial sum of money that was borrowed or invested.

Simple Interest Formula

The formula for calculating Simple Interest is:

Simple Interest = Principal x Rate x Time

Where:

  • Principal is the initial amount of money
  • Rate is the interest rate per period
  • Time is the time period for which the interest is calculated

Example of Simple Interest Calculation

For instance, if you deposit $1,000 in a bank account with a Simple Interest rate of 3% per year, after one year you would earn $30 in interest. This is calculated as follows:

Simple Interest = $1,000 x 0.03 x 1 = $30

Difference Between Simple Interest and Compound Interest

The main difference between Simple Interest and Compound Interest lies in how the interest is calculated. With Simple Interest, the interest is only computed based on the original principal, while with Compound Interest, the interest is added to the principal amount, and subsequent interest is calculated on the new total.

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