What is Simple Interest?

Simple interest is earned or paid on the principal amount only. You don’t pay or get interest on your interest, just on the principal. Simple interest is not widely used in the world of business and personal finance. Mostly it is compound interest that is used. (see below).

There is a simple formula to figure out simple interest as follows:

I = Prt. Interest equals principal times the interest rate times the period of time.

Here’s an example. You borrow $1,000 for a year at a rate of 6%. If you plug these figures into our formula, then here’s what you get: Interest = ($1,000) X (.06) X (1). In English this is: Interest equals $1,000 times 6% times one year. Your answer is $60.

You may have to tweak the time element if it is not in increments of one year. For example, if you want to figure the interest for nine months instead of a year, then you would use .75 for the time component. If you wanted to figure the interest for a year and a half, then you would use 1.5 for the time component.

It doesn’t matter if this is simple interest you are paying (such as taking out a loan) or simple interest you are getting (such as investing in a bank CD), the simple interest is figured the same way. You just pay on the principal – the original amount borrowed or invested.