Lesson 4 of 10
Simple interest
Simple interest applies the rate to the original principal, without interest on prior interest.
The idea
Principal is the starting amount. In a simple-interest illustration, interest equals principal multiplied by the rate and the time. Keep the units consistent: an annual rate must be paired with time expressed in years.
Use the calculation to isolate what a quoted rate means. Actual financial products can use daily balances, fees, different day-count conventions, and other terms; the simple model does not reproduce every contract.
Worked example
Original arithmetic example: $1,000 at a hypothetical 5% annual simple rate for three years earns $1,000 × 0.05 × 3 = $150. The ending amount is $1,150. Each year adds $50 because the calculation always uses the original $1,000.
| Year | Interest this year | Total balance |
|---|---|---|
| 0 | $0 | $1,000 |
| 1 | $50 | $1,050 |
| 2 | $50 | $1,100 |
| 3 | $50 | $1,150 |
A common mistake
Typing 5 as a decimal rate instead of 0.05, or using 18 months as 18 years.
Try it yourself
Calculate simple interest on $2,000 at 6% annually for 18 months. Convert the time to years before multiplying.
Show the worked answer
18 months = 1.5 years. Interest = $2,000 × 0.06 × 1.5 = $180. Ending amount = $2,180.