What is Simple Interest?
Simple interest is a basic formula for calculating how much interest to apply to a principal balance.
Simple Interest Formula:
Simple Interest = Interest Rate x Principal Balance
Simple Interest Example
For example, let's assume that John Doe puts $1,000 in his savings account. The bank pays 3% per year in interest. Using this information and the simple interest formula above, we can calculate how much interest he will earn in a year:
Simple Interest = 0.03 x $1,000 = $30
Why Simple Interest is Important
Simple interest is a handy, easy tool for estimating the interest earned or paid on a certain balance in one period. However, it does not take into account the effects of compounding, which is the process of earning interest on principal plus interest that was earned earlier. This means it can dramatically understate the amount of interest earned or paid over time.