What is 'Simple Interest'

Simple interest is a quick method of calculating the interest charge on a loan. Simple
interest is determined by multiplying the daily interest rate by the principal by the
number of days that elapse between payments.

This type of interest usually applies to automobile loans or short-term loans, although
some mortgages use this calculation method.

BREAKING DOWN 'Simple Interest'

When you make a payment on a simple interest loan, the payment first goes toward that
month’s interest, and the remainder goes toward the principal. Each month’s interest is
paid in full so it never accrues. In contrast, compound interest adds some of the monthly
interest back onto the loan; in each succeeding month, you pay new interest on old
interest.

Examples of Simple Interest

To understand how simple interest works, examine an automobile loan that has a Php
15,000 principal balance and an annual 5% simple interest rate. If your payment is due
on May 1 and you pay it precisely on the due date, your interest is calculated on the 30
days in April. Your interest for 30 days is Php 61.64 under this scenario. However, if you
make the payment on April 21, the finance company charges you interest for only for 20
days in April, dropping your interest payment to Php 41.09, a Php 20 savings.

Who Benefits From a Simple Interest Loan?

Because simple interest is calculated on a daily basis, it is mostly beneficial for

consumers who pay their loans on time or early each month. Under the scenario above,
if you sent a Php 300 payment on May 1, then Php 238.36 goes toward principal. If you
sent the same payment on April 20, then Php 258.91 goes toward principal. If you can
pay early every month, your principal balance shrinks faster, and you pay the loan off
sooner than the original estimate.

Conversely, if you pay the loan late, more of your payment goes toward interest than if
you pay on time. Using the same automobile loan example, if your payment is due on
May 1 and you make it on May 16, you are charged for 45 days of interest at a cost of
Php 92.46. This means only Php 207.54 of your Php 300 payment goes toward
principal. If you consistently pay late over the life of a loan, your final payment will be
larger than the original estimate because you did not pay down the principal at the
expected rate.

What Types of Loans Use Simple Interest?

Simple interest usually applies to automobile loans or short-term personal loans. Most
mortgages do not use simple interest, although some banks use this method for
mortgages that have a bi-weekly payment plan. Bi-weekly plans help consumers pay off
their mortgages early because the borrowers make two extra payments a year and
more frequent payments result in interest savings.

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What is Simple Interest?

Simple interest is a type of interest that is applied to the amount borrowed or invested
for the entire duration of the loan, without taking any other factors into account, such as
past interest (paid or charged) or any other financial considerations.

Simple Interest is generally applied to short term loans, usually one year or less that are
administered by financial companies. The same applies to money invested for a
similarly short period of time.

The simple interest rate is a ratio and is typically expressed as a percentage. It plays an
important role I determining the amount of interest on a loan or investment. The amount
of interest charged or earned depends in three important quantities that we will examine
next.

Simple Interest Formula

EX: Sarah needs to borrow Php 2000 in order to buy furniture. She’s approved for two
different loans. Loan one allows her to borrow Php 2000 now, provided that she pay off
the loan returning Php 2200 exactly one year from the day that she borrows the money.
Loan two offers her Php 2000 upfront as well, with a similar loam period of one year at
an annual interest rate of 7%. Which is the better deal for Sarah?

The amount borrowed or invested is called the principal. Using the example above,
when Sarah borrows Php 2000 to buy furniture, we say that the principal is Php 2000.

Its customary for financial institutions to quote a quantity called the interest rate as a
percentage. This interest rate represents a ratio of the principal borrowed or invested.
Typically, this interest rate is given as a percentage per year, in which case it is called
the annual interest rate. For example, if we borrow Php 100 at an annual rate of 5%, it
means that we will be charged 5% of Php 100 at the end of the year, or Php 5.

The loan period or duration is the time that the principal amount is either borrowed or
invested. It is usually given in years, but in some cases, it may be quoted in months or
even days. If that is the case, we need to perform a conversion from a period given in
months or days, into years.

The simple interest formula allows us to calculate I, which is the interest earned or
charged on a loan. According to this formula, the amount of interest is given by I = Prt,
where P is the principal, r is the annual interest rate in decimal form, and t is the loan
period expressed in years.

Example

The second offer that Sarah has received is to borrow a principal amount P = Php
2,000, at an annual rate of 7%, over t = 1 year. The rate r must be converted from a
percentage into decimal form, which means that we divide the percentage value 7% by
100 to get r = 0.07.

We now calculate the amount of interest Sarah would be charged if she accepts the
loan offer just described:

I = Prt = (2,000)(0.07)(1) = Php 140.

Following our example, we determined that if Sarah accepts the second loan, the
interest that she will owe the bank is Php Php 140. So, how much would Sarah have to
pay the bank in order to pay off her debt? She would have to pay back the money she
borrowed, or the principal, which is Php 2,000, and she would have to pay the bank the
interest we calculated, in which I = Php 140. Thus, she will owe the bank Php 2,000 +
Php 140, which equals Php 2,140. We note that this is still less than the Php 2,200
Sarah would have to pay if she accepts Loan One. Obviously, Loan Two is the better
choice.

Future of Maturity Value

The total amount we would need to pay back when we take a loan is called the future
value of the loan. Another name for future value is maturity value. The future value, A,
of a loan is given by the equation A = P + I. When we invest a principal amount (P), the
future value (A) will represent the total amount we will have at the end of the loan period
after simple interest is applied.

Using the interest formula I = Prt, we can derive a formula for the future value, since A =
P + Prt, or after factoring out P on the right hand side, A = P(1 + rt).

Example 1

Lilya borrows Php 300 from her local bank at an annual interest rate of 3.25% to be paid
back in six months. How much interest will she pay at the end of the loan?

Solution

We are given the following values: the principal amount, P = 300, the annual interest
rate, r = 3.25%, and the loan period t in years. The loan period is six months, so we
have t = ½, calculated by dividing six months into 12 months, the number of months in a
year.

t = loan period in months / 12 months in a year = 6 / 12 = 1/2

The value of r is determined by converting it from a percentage into decimal form:

r = annual rate as a percentage / 100 = 3.25 / 100 = 0.0325

We now use the interest formula, I = Prt, to determine the interest to be paid at the end
of the loan:

I = Prt = (300) (0.0325) (1/2) = 4.875

This value will be rounded to Php 4.88 by the bank, as it is more profitable to them.
Therefore, Lilya will have to pay back Php 4.88 in interest.

What Is a Principal Amount?

Principal amount on a loan is the amount borrowed. To better understand, let's look at
the story of John. When John bought his first car he didn't have enough money to pay
for it in cash, so he had to take out a loan. He borrowed Php 7,500. According to the
terms of the loan, John had to pay it off in five years with an interest rate of 10%. The
initial amount that he borrowed, or the Php 7,500, is called the principal amount of the
loan. Keep in mind that the principal amount applies to more than just loans. It can also
apply to money that is invested or deposited into an account. For example, if you open a
savings account with a Php 700 deposit, the principal amount is Php 700.

What About Interest?

Principal amount does not include interest, or a

rate paid as a fee for borrowing money. To
figure out the amount of interest John paid
during the five years, you can use the simple interest formula, which is a formula to
calculate interest paid only on the principal amount. This formula is:

or interest equals principal amount times interest rate times amount of time. Using this
formula, you will find that the amount of interest on John's Php 7,500 loan was Php
3,750. So, at the end of five years, he would end up paying a total of Php 11,250. This
does not include any additional fees that may apply.

Principal Amount Formulas

For John's loan, we were given the principal amount and used it to find the amount of
interest. What if we already know the interest rate, amount of interest, and amount of
time, but we need to find out the principal amount? We can rearrange the interest
formula, I = PRT to calculate the principal amount. The new, rearranged formula would
be P = I / (RT), which is principal amount equals interest divided by interest rate times
the amount of time.

Let's try this out by finding the principal amount of a loan that has a total interest amount
of Php 18,500 and an annual interest rate of 6.5% over 12 years.

To solve, we input the values into the equation, P = I / (RT). This gives us:

P = Php 18,500 / (0.065 * 12) = Php 23,718

The principal amount of the loan is Php 23,718.

Definition of Interest Rates

Interest rates, in the simplest terms, are the costs to borrow money or the return for
lending money. Interest rates are percentages, although they are often referred to
as points in finance lingo. For example, if mortgage rates went from 3% to 4%,
amateurs would say 'rates went up one percent' while finance professionals would say
'rates went up a whole point.' There's a legitimate reason for that, not just so
professionals sound fancy. Technically speaking, if mortgage rates were at 3% and they
'went up 1%', that means they went up 1% of 3%, so now they are 3.03% (.03% = 1% of
3%).

The History of Interest Rates

While mortgages and credit cards are relatively new financial instruments - developed
within the last fifty years - interest rates have been around since the ancient
civilizations. The need for interest rates arose from societies that started to build cities
and farm the land, instead of following the herds like their hunter-gatherer ancestors.
One person would grow grain and someone else would raise livestock. The person
raising livestock wasn't paid until the livestock was grown and slaughtered, but they
needed grain to get to that point. So, a system was created where the grain farmer
would lend grain to the livestock rancher, who would then pay back his loan with goods
he received by selling his livestock. No one shopped around for interest rates at that
time - one grain farmer didn't charge a lower rate than the others. Instead, rates were
set as laws. In Ancient Mesopotamia, the interest rate on grains was 20%.

Like the rest of the field of economics, the concepts of interest rates became
significantly more complex during the industrial revolution. As businesses needed
capital to grow, banks began fulfilling the role of moving capital from savers to
borrowers and setting the rates based on the supply and demand of money. In the early
1900s the Federal Reserve Bank was formed, which took interest rates from a term in a
loan agreement to a primary tool of monetary policy.
Types of Rates

There are many types of interest rates. Mortgage rates, auto loan rates, and credit card
rates are all common rates that most people pay, and they each vary based on where
you are, what you need it for, how much money you borrow, and your credit
profile. Rates of return on savings accounts, money market accounts, investments, and
bonds are all common interest rates many people are paid; but again, they vary based
on many different factors. Finally, there are benchmark rates. These are rates that are
set by central banks or other bodies that financial institutions use as a baseline for
setting their own rates. Some examples of benchmark rates include the LIBOR rate,
Fed Funds Rate, Prime Rate, and one-year treasury rate.

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MATURITY VALUE FORMULA

After understanding the basics behind simple interest, we can now learn about the
maturity value formula.

Consider a loan with the principal 'P', with interest rate per year of 'r'%, and the loan
duration is 't' years.

Derive the maturity value formula.

Now, the maturity value is the total amount of money that we need to pay back, after the
loan duration.

To explain this, let's represent this green bar as the loan's Principal.

And, represent the yellow bar as the loan's interest.

Now, we can find the total amount of money to pay back, by adding the 'principal'
together with the 'interest'.

Knowing this, we can write the equation, maturity value, equals to principle, plus
interest.

Next, let’s represent the maturity value as S, principle as ‘P’ and interest as ‘I’.

Now, from the previous lesson, we learn that the simple interest, I=Prt. Therefore, we
can change this, I to Prt.

Notice that, these 2 terms, have 'P' as a common factor.

Hence, we can factorize these terms, by taking out ‘P’ in each term.

By doing so, we get, P(1+rt).

Finally, we have the formula for maturity value, S=P(1+rt).

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Example:

Sarah deposits Php 4,000 at a bank at an interest rate of 4.5% per year. How much
interest will she earn at the end of 3 years?

Solution:
Simple Interest = 4,000 × 4.5% × 3 = 540

She earns Php 540 at the end of 3 years.

Example:

Wanda borrowed Php 3,000 from a bank at an interest rate of 12% per year for a 2-year
period. How much interest does she have to pay the bank at the end of 2 years?

Solution :

Simple Interest = 3,000 × 12% × 2 = 720

She has to pay the bank Php 720 at the end of 2 years.

Example:

Raymond bought a car for Php 40, 000. He took a Php 20,000 loan from a bank at an
interest rate of 15% per year for a 3-year period. What is the total amount (interest and
loan) that he would have to pay the bank at the end of 3 years?

Solution :

Simple Interest = 20,000 × 13% × 3 = 7,800

At the end of 3 years, he would have to pay

20,000 + Php 7,800 = Php 27,800

Tutorial on Simple Interest

Examples:
1. Ian is investing Php 4,000 for 2 years. The interest rate is 5.5%. How much interest
will Ian earn after 2 years? 

2. Doug made a 3 year investment. The interest rate was 4.5%. After 3 years, he
earned Php 675 in interest. How much was his original investment?

3. Kim got a loan of Php 4700 to buy a used car. The interest rate is 7.5%. She paid
Php 1057.50 in interest. How many years did it take her to pay off her loan?

Word Problems on Simple Interest are solved here:

1. Robert deposits Php 3000 in State Bank of India for 3 year which earn him an interest
of 8%.What is the amount he gets after 1 year, 2 years and 3 years?

Solution:

In every Php 100, Robert gets Php 8.

(Since rate is 8% → 8 for every 100)

Therefore, for Php 1 he gets = Php 8/100

And for Php 2000 he gets = 3000 x 8/100 

= Php 240

Simple Interest for 1 year = Php 240.

Simple Interest for 2 year = Php 240 x 2 

= Php 480

Simple Interest for 3 year = Php 240 x 3

= Php 720

Therefore, Amount after 1 year = Principal (P) + Simple Interest (SI)

= 3000 + 240

= Php 3240

Amount after 2 years = Principal (P) + Simple Interest (SI)

= 3000 + 480

= Php 3480

Amount after 3 years = Principal (P) + Simple Interest (SI)

= 3000 + 720 = Php 3720

We observe from the above example that, the Interest cannot be calculated without
Principal, Rate and Time.

Therefore, we can conclude that Simple Interest (S.I.) depends upon:

(i) Principal (P)

(ii) Rate (R)

(iii) Time (T)

And therefore, the formula for calculating the simple interest is

Simple Interest (SI) = {Principal (P) × Rate (R) × Time (T)}/100

Amount (A) = Principal (P) + Interest (I)

Principal (P) = Amount (A) – Interest (I)

Interest (I) = Amount (A) – Principal (P)

2. Richard deposits Php 5400 and got back an amount of Php 6000 after a year. Find
the simple interest he got.

Solution:

Principal (P) = Php 5400,

Amount (A) = Php 6000

Simple Interest (SI) = Amount (A) – Principal (P)

= 6000 - 5400

= 600

Therefore, Richard got an interest of Php 600.

3. Seth invested a certain amount of money and got back an amount of Php 8400. If the
bank paid an interest of Php 700, find the amount Sam invested.

Solution:

Amount (A) = Php 8400,

Simple Interest (SI) = Php 700

Principal (P) = Amount (A) – Interest (I)

= 8400 - 700

= 7700

Therefore, Seth invested Php 7700.

4. Diego deposited Php 10000 for 4 year at a rate of 6% p.a. Find the interest and
amount Diego got.

Solution:

Principal (P) = Php 10000, 

Time (T) = 4 years,

Rate (R) = 6% p.a.

Simple Interest (SI) = {Principal (P) × Rate (R) × Time (T)}/100

= (10000 x 6 x 4)/100 

= Php 2400

Amount (A) = Principal (P) + Interest (I)

= 10000 + 2400

= Php 12400

The interest Diego got = Php 2400.

Therefore, the amount Diego got Php 12400.

Solve each of these interest problems:

1) You get a student loan from the New Mexico Educational Assistance Foundation to
pay for your educational expenses this year. Find the interest on the loan if you
borrowed Php 2,000 at 8% for 1 year. (You may wish to use the percent key on your
calculator or change 8% to .08)

2) You are starting your own small business in Albuquerque. You borrow Php 10,000
from the bank at a 9% rate for 5 years. Find the interest you will pay on this loan. Simple
Interest Problems Revised @ 2009 MLC page 2 of 2

3) You are tired at the end of the term and decide to borrow Php 500 to go on a trip to
Whatever Land. You go to the bank and borrow the money at 11% for 2 years.

a) Find the interest you will pay on the loan.

b) How much will you have to pay the bank at the end of the two years?

4. a) Find the interest on a loan of Php 2500 that is borrowed at 9% for 7 months.

b) How much would it cost to repay the loan from 4a) above?

Simple Interest Word Problems

1. Jamie wants to earn Php 500 in interest so she’ll have enough to buy a used car. She
puts Php 2000 into an account that earns interest. How long will she need to leave her
money in the account to earn Php 500 in interest?

2. A local bank is advertising that you can double your money in eight years if you invest
with them. Suppose you have Php 1000 to invest. What interest rate is the bank
offering?

3. Kelly plans to put her graduation money into an account and leave it there for 4 years
while she goes to college. She receives Php 750 in graduation money that she puts it
into an account that earns 4.25% interest. How much will be in Kelly’s account at the
end of four years?

4. Randy wants to move his savings account to a new bank that pays a better interest
rate of 3.5% so that he can earn Php 100 in interest faster than at his old bank. If he
moves Php 800 to the new bank, how long will it take for him to earn the Php 100 in
interest?

5. Php 9600 is invested at 8% per annum for 5 years.

(a) What is the simple interest payable?

(b) Find the amount accruing for the investment. (ending balance) 6. Find the principal
that will earn Php 294 in 5 years at 6% simple interest.

7. The simple interest on Php 12 000 invested at 8% per annum is Php 6 720. Calculate
the number of years for which the sum was invested.

8. The simple interest on Php 15 000 for 9 years is Php 6750. Calculate the rate per
cent per annum.

9. How long does it take a principal of Php 25,000 at a simple interest rate of 5% to
become Php 30,000?
10. Php 45,000 is deposited into a savings account. Calculate the maturity value
(accumulated balance) of this investment if:

a. it earns 1.5% simple interest per month for 2 years

b. it earns 9.4% simple interest per year for 2 years

11. Find the total amount of simple interest that is paid over a period of five years on a
principal of Php 30,000 at a simple interest rate of 6%.

12. Calculate the total worth of an investment after six months with a principal of Php
10,000 at a simple interest rate of 3.5%.

13. Calculate the compound interest earned when Php 8 500 at 8% per annum for: a. 3
years b. 8 months

14. Which is the better investment?

a) Php 1 200 at 9% simple interest per annum for 2 years.

b) Php 1 200 at 8% compound interest per annum for 2 years.

15. Which is the better investment?

a) Php 15,000 at 0.75% simple interest per month for 2 years.

b) Php 15,000 at 0.2% compound interest per month for 2 years.

Part I: Find Simple Interest and Maturity Value when time is given in years or
months.

Example 1: Mary borrowed Php 12,354 to buy a car. The loan was for 3 year at an
annual interest rate of 7.5%. What is the amount of interest Mary paid? What is the
maturity value of the loan?

I. Calculate interest.

I=P*R*T

I = Php 12,354 * 0.075 * 3

I = Php 2779.65

II. Calculate maturity value.

Maturity Value is the total amount to be repaid to the bank (the principal plus the
interest).

MV = P + I

MV = Php 12,354 + Php 2779.65

MV = Php 15,133.65

Example 2: When the time is given in months, the number of months must be put over
12. The “time” must be in years, so number of months / 12 = time in years.
Nancy Williams borrowed Php 4,325 to buy furniture for her office. The loan was for 6
months at an annual interest rate of 9%. What is the amount of interest Nancy paid?
What is the maturity value of the loan?

I. Calculate interest.

I=P*R*T

6
I = Php 4,325 * 0.09 * 12

Note the time is 6 months, so it must be put over 12 months. This reduces to ½ year.

1
I = Php 4,325 * 0.09 * 2

I = Php 194.63 (rounded to the nearest cent)

II. Calculate maturity value.

MV = P + I

MV = Php 4,325 + Php 194.63

MV = Php 4,519.63

Part III: Find Simple Interest and Maturity Value when time is given in days using
exact interest and ordinary interest.

Exact interest: denominator is 365

Ordinary interest (banker’s year) denominator is 360

Example 5: Juan Sanchez borrowed Php 11,325 for 45 days at 8% annual interest.
What is the amount of interest Juan paid? What is the maturity value of the loan? Use
exact interest.

I=P*R*T

45
I = Php 11,325 * 0.08 * 365

I = Php 111.70 (rounded to the nearest cent)

MV = P + I

MV = Php 11,325 + Php 111.70

MV = Php 11,436.70

Example 6: Tomas Sanchez borrowed Php 11,325 for 45 days at 8% annual interest.
What is the amount of interest Juan paid? What is the maturity value of the loan? Use
ordinary interest.

I=P*R*T
 45
I = Php 11,325 * 0.08 * 360

I = Php 113.25

MV = P + I

MV = Php 11,325 + Php 113.25

MV = Php 11,438.25

NOTE: ***Tomas paid more interest because of ordinary interest!

Part IV: Find the unknown in Simple Interest Formula.

In this section, you will use algebraic methods learned in Chapter 5 to solve for the
unknown.

Example 7: Joseph Roberts borrowed Php 553 for 3 years. He paid Php 132.72 in
simple interest. What is the annual rate?

I=P*R*T

Php 132.72 = Php 553 * R * 3 Multiply 553 * 3

Php 132.72 = Php 1659 * R

or

1659R = 132.72 Divide by the coefficient of R: 1659

1659 R 132.72

1659 1659

R = 0.08 = 8%

The annual rate is 8%.

Example 8: Yue Chen borrowed some money from the bank at an 11% annual rate for
5 years. She paid Php 1,375 in interest. How much money did she borrow?

I=P*R*T

Php 1,375 = P * 0.11 * 5 Multiply 0.11 * 5

Php 1,375 = P * 0.55

or

0.55 P = 1,375 Divide both sides of the equation by 0.55

0.55 P 1,375

0.55 0.55

P = Php 2,500
Yue borrowed Php 2,500.

Example 9: Stephanie Johnson borrowed Php 1,300 at 7.5% annual interest rate. She
paid Php 48.75 in interest. How long (in years) did she have the loan?

I=P*R*T

Php 48.75 = Php 1,300 * 0.075 * T Multiply Php 1,300 * 0.075

Php 48.75 = 97.5 * T

or

97.5T = 48.75 Divide both sides of the equation by 97.5

97.5T 48.75

97.5 97.5

T = 0.5 or ½ year

Stephanie had the loan for ½ year.

Now convert this to months and days.

I. Convert to months.

½ year * 12 months = 6 months.

II. Convert to days.

A. Exact interest use 365 days.

½ year * 365 days = 182.5 days

B. Ordinary interest use 360 days.

½ year * 360 days = 180 days

Practice Problems:

1. Tyler Holly borrowed Php 8,300 for 16 months at 6.5%. What is the amount of
interest he paid? What is the maturity value of the loan?

2. John Roberts borrowed Php 16,000 for 9 months at 11.5%. What is the amount
of interest he paid? What is the maturity value of the loan?