Simple interest is a method of calculating interest where the interest charge is based only on the original principal amount. Unlike compound interest, simple interest does not factor in previously accumulated interest. It is calculated using the formula: Interest = Principal × Rate × Time. Simple interest is commonly used for short-term loans, auto loans, and some personal loans.
Simple Interest
Definition
Simple interest is a method of calculating interest where the interest charge is based only on the original principal amount. Unlike compound interest, simple interest does not factor in previously accumulated interest. It is calculated using the formula: Interest = Principal × Rate × Time. Simple interest is commonly used for short-term loans, auto loans, and some personal loans.
Example
You take out a $10,000 personal loan at 8% simple interest for 3 years. The total interest is $10,000 × 0.08 × 3 = $2,400. You repay a total of $12,400. With compound interest at the same rate, you would owe $12,597 — $197 more.
Key Points
- 1Calculated only on the original principal amount
- 2Formula: Interest = Principal × Rate × Time
- 3Results in lower total interest compared to compound interest
- 4Common in auto loans, personal loans, and Treasury notes