As an individual, it is important that you understand some basic concepts in the financial world. It doesn’t matter whether you are a professional or not. Understanding these concepts will help you make better decisions about your finances. One of these concepts is what we call the simple Interest.
Basically, simple interest is a fast and easy way to calculate the interest that a financial institution charge on your loan. You can calculate this by simply multiplying your daily interest rate by the principal and by the number of days that elapse between payments.
Simple interest generally applies to automobile loans and short-term loans. In this article, we will be discussing all that you need to know about simple interests. This includes the full definition, how to calculate it, how it works, and every other thing you need to know.
What is Simple Interest?
Basically, simple interest is more or less a charge or fee you pay on a loan. In another circumstance, it could also be the income you earn on a deposit. The concept of simple interest is applicable in these three scenarios:
- When borrowing money:
Anytime you borrow money from a lender or financial institution, you will agree that it is a must that you repay the amount you lent with some interest. In this case, this basically represents the cost or charge of borrowing. This charge is the simple interest.
- When lending money:
If you are borrowing someone a certain amount, you will definitely set a rate and earn interest income. This is in exchange for making your money available to other people.
- When depositing money:
Interest-bearing accounts in financial institutions such as banks pay interest income. They do this because you one way or the other make money available to them to lend to others.
How do I calculate Simple Interest?
Calculating simple interest as the name implies means that you are using the easiest or simplest means to calculate interest. Once you understand this concept, it will be very easy for you to calculate concepts such as compound interest, Annual Percentage Rate (APR).
The formula for calculating Simple Interest, you can use this formula = Principal X rate X time = Interest
For example, let’s assume you invest N100 at a 5% annual rate for one year. Then, your simple interest will be: N100 X 0. 05 X1 =N5. Therefore, your simple interest for one year will be N5.
Note, if you are calculating simple interest over one year, calculate the interest earnings using the principal from the first year. Multiply this by the interest rate and the total number of years.
What are the Limitations of Simple Interest?
As we have already stated, simple interest is a basic way of calculating interest. But the fact is, it has some limitations when it comes to calculating more complex interest calculations. For example, if you are to calculate a 30-year mortgage loan using simple interest, your calculations might not be entirely correct. However, it is important to note that understanding the basics of simple interest is a good start to understanding how much your loan will cost or what your ROI will be.
Understanding the concept of simple interest is a good way to manage your finances effectively. Although that is not the end to interest calculations, it is a stepping stone to lead you further to other complex concepts.