What is Simple Interest?
Simple interest is a basic concept important to investments such as short-term notes or Treasury bills (T-bills), which typically cover time periods less than a year, but also longer term investments such as municipal or other types of bonds.
The investor invests a principal amount of money at a fixed interest rate, without compounding.
At the maturity date, the investor gets the principal back, plus the interest.
How to Calculate Simple Interest
To calculate the amount of simple interest, we can use the simple interest formula and multiply the principal amount with the annual interest rate and the time in years.
Example Simple Interest Calculation
Question: What is the interest on a loan of $1,000 at 11% for 10 months?
I = P r t = $1,000 * 0.11 * 10/12 = $91.67
At the end of the 10 months, the borrower will pay the principal, $1,000, plus the interest, $91.67, for a total of $1,091.67.
Simple Interest and Future Value
Building on the simple interest equation above, we can express the total amount, or future value (A) to be paid back to the investor as follows:
Example Future Value Calculation
Question: What is the total amount due on a loan of $1,400 at 8% simple interest at the end of 6 months?
A = P (1 + rt) = $1,400 * (1 + 0.08 * 6/12) = $1,456.00
The total amount due at the end of 6 months is $1,456.00.