Teaching How to Calculate Interest to Children

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Learning about interest calculations at an early age helps children grasp the advantages of lending and the disadvantages of borrowing. As soon as children understand percents, decimals and know how to multiply, they can learn about simple and compound interest. Simple interest is interest paid only on the principal amount borrowed. Compound interest is interest on the principal plus the accrued interest. Teach children with a conceptual background and hands-on examples of the calculations.

Simple Interest

Tell students about the concept of interest, which is money that a person charges another person to borrow money. Explain that if you are borrowing money, you pay interest, but if you are lending money through a savings account or other investment, you earn interest.

Explain that the interest rate is the percent of the money owed that the borrower pays the lender each year.

Explain that you can convert a percentage to a decimal by dividing it by 100.

Use play money as a simple example. Have a child lend you $100 in play money. Discuss how much interest you have to pay the child each year at different interest rates. For example, at 5 percent interest, you pay $5 per year and at 13 percent interest, you pay $13 per year.

Give children the formula for simple interest: I = P_R_T. I is the amount of interest, P is the principal amount borrowed or lent, R is the decimal version of the interest rate and T is the time, or the number of years. The symbol "*" represents times, so to calculate the interest, you multiply the principal by the decimal version of the principal by the number of years.

Work through an example together using simple numbers. For example, say that a child invested $200 at 6 percent interest for three years. Plug these into the formula to get I = $200_0.06_3. Solve to calculate $36 in interest.

Compound Interest

Explain to older children that if interest is deposited into the account instead of going to the customer, then the customer's account balance will change, which will change the amount of interest earned next month.

Give children the formula for compound interest: A = P(1+r/n)^nt. Explain that A is the amount in the account at a future date, P is the principal, or the amount initially invested, r is the annual interest rate as a decimal, n is the number of compounding periods per year and t is the number of years interest accrues. The symbol "^" means "to the power of."

Work through an example together. Say that someone invests $1,000 at 5 percent interest, compounded monthly, for 20 years. Therefore, the formula is A = $1,000(1+0.05/12)^(12*20). Doing all of the math leads to a solution that A is $2,712.64.

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