In my old post, I compared simple interest with compound interest and what are the differences between the two. In this article, I would like to show you how to compute for simple interest since it is a basic lesson in finance that every people should learn.
To give you basic understanding, an interest is the fee paid to a depositor like you for the use of money you put in the bank. For example, if you put P10,000 in your savings account or time deposit, the bank will pay a fee (interest) to you as a depositor in form of an interest which can be simple or compounded.
In order for depositors to understand better how much they could earn from their deposits, banks and other financial institutions use interest rate to quantify and explain better the fee they are paying to each depositor.
In addition, if you are applying for a bank loan, the bank should tell you the interest rate so you would know how much you will pay each month called the monthly payment or amortization. Some banks give interest rate on the yearly basis called annual interest rate or annual percentage yield (APR).
What is Simple Interest?
A simple interest is calculated only based on the principal amount, the period interest rate and the duration of how long the interest will be paid. The time value of money is not considered when dealing with simple interest. The only important factors here are the things mentioned above as opposed to compound interest which considers time as a big factor.
How to Compute Simple Interest
It is easy to compute for simple interest. In order to understand better, you should look at the following equation below:
S = r*P*t
where S = simple interest
r = interest rate
P = principal amount
t = duration the interest is paid
For example, you have P10,000 in your savings account. You want to compute how much interest it will gain after 5 months with 0.25% interest per year, which is the common rate for most banks these days. So the simple interest will be:
S = r*P*t
S = (0.0025/12)*10,000*5
S = 10.42
Therefore, your account will earn only P10.42 for a 5-month period. In one year, it will give you only P125. However, imagine your savings account balance has P100,00 or P1 million, the interest will be higher and substantial. Try computing for P1 million. How much interest will you get?
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