What Is the Definition of a Simple Interest Rate?
The cost of borrowing money is known as interest. An interest rate is basically the cost stated as a percentage of the money borrowed over a specified period of time, typically 12 months. Simple interest rate is evaluated on the original principal.
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Calculation
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Simple interest rate is calculated only on the original principal, which means the accumulated interest from previous time periods is not added during the calculations for the periods to come.
Usage
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Simple interest is commonly used only for a single period of time, which is normally less than 12 months (for example, 25 or 50 days).
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Formula
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According to MoneyInstructor.com, the formula for simple interest is: I= Prt, where I = Interest, P = principal, r = interest rate/year and t = time.
Sample Calculation
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Let's say you borrow $10,000 from the bank to make a down payment for a house. You agree to pay it back in eight months on simple interest at the rate of 10 percent per year. If you manage to pay the full $10,000 in the specified duration, the interest would be $10,000 (0.10) (15/12) = $1,250.
Difference
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Simple interest is contrasted with compound interest, which is similar except that in compound interest, the amount to be given at the end of each specified period is calculated and the interest is charged against the original principal as well as the interest that is earned during the specified period.
Limitations
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Simple interest gives a basic idea about loan costs and investments. It does not take into account the compounding factor.
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