Interest only on the original principal
Simple interest pays the rate on the original principal, and only on that principal, for the whole term. The formula is I = P × r × t, with r written as a decimal, or I = P × rate × years ÷ 100 when the rate is in percent. For P = $10,000, a rate of 5% a year, and t = 3 years: I = 10,000 × 5 × 3 ÷ 100 = 1,500. The interest is $1,500.00. The amount at the end is the principal plus the interest, $11,500.00. Nothing in that total was itself earning interest.
That last point is the definition. Compound interest would add each period’s interest to the principal and then pay interest on the new, larger balance. Three years at 5% compounded annually turns $10,000 into $11,576.25, which is $76.25 more than simple interest. This page does not do that. If a note, a bond, or a loan says “simple interest,” the $1,500 figure is the one that matches the contract. If it says “compounded monthly” or “APY,” it does not.
Worked example with part of a year
The same 5% note on $10,000 held for 3 years and 6 months uses a time of 3.5 years, because 6 months is half a year.
- Time = 3 + 6/12 = 3.5 years.
- Interest = 10,000 × 5 × 3.5 ÷ 100 = $1,750.00.
- Total = 10,000 + 1,750 = $11,750.00.
- Per year, the interest is still $500, because 5% of $10,000 is $500. The extra half year adds another $250.
Read the rate before you type it
The rate box is an annual rate in percent. A monthly rate of 1% is not 1 in that box. Twelve times 1% is 12% a year, and you would enter 12 if the contract really is simple interest at 1% a month. Some consumer loans quote a daily rate and a 365-day year. Convert that to a yearly percent, or enter the time as a fraction of a year that matches the contract, before you compare offers. Two loans with the same “5%” can differ if one counts a year as 360 days and the other as 365.
The result is the interest charge or the interest earned, not a monthly payment on an amortizing loan. An installment loan applies each payment to interest and principal, which is a different schedule. Use this page for a note that charges simple interest on a fixed principal, a short-term loan quoted that way, or a textbook problem that says “simple interest.”