Table of Contents

4 Ways Simple Interest Is Used in Real Life

By

澳洲幸运5开奖号码历史查询:Elvis Picardo

Updated August 15, 2023

Reviewed by

Michael J Boyle

Fact checked by

Katrina Munichiello

Simple interest is the cost of using or borrowing money without compound interest or interest on interest. It's relatively easy to calculate since you only need to base it on the principal amount of money borrowed and the time period.

Simple interest works in your favor when you're a borrower because it keeps the overall amount that you pay lower than it would be with 澳洲幸运5开奖号码历史查询:compound interest; however♑, it can work against you when you're an inve൩stor because you'll want your returns to compound as much as possible to get the most from your investment.

To understand how ⛎it works, it helps to look at some real-life situations🎃 in which simple interest is used, including car loans, other consumer loans, certificates of deposit, and discounts on early payments.

Key Takeaways

Simple interest is what it costs to borrow money without compound interest, which is interest on the principal and on the interest.
Simple interest is calculated by looking at the principal amount borrowed, the rate of interest, and the time period it will cover.
Simple interest is more advantageous for borrowers than compound interest, as it keeps overall interest payments lower.
Car loans, amortized monthly, and retailer installment loans, also calculated monthly, are examples of simple interest; as the loan balance dips with each monthly payment, so does the interest.
Certificates of deposit (CDs) pay a specific amount in interest on a set date, representing simple interest.

1. Car Loans

Car loans are 澳洲幸运5开奖号码历史查询:amortized monthly, which means that a portion of the loan goes to pay th🌺e outstanding loan balance every month, and the remainder goes toward the interest paymeℱnt.

As the outstanding loan balance diminishes every month, the interest payable reduces, which means a greater part of the monthly payment goes toward the principal 澳洲幸运5开奖号码历史查询:repayment.

For example, assume you have a car loan for $20,000. Your interest rate is 4%. To find the simple interest, we multiply 20000 × 0.04 × 1 year. So, by using simple interest, $20,000 at 4% for 5 years is ($20,000*0.04) = $800 in interest per year.

The total payment due would be $800/year * 5 years + $20,000 = $24,000. Then, the monthly interest is $800 / 12 = $66.67. You take the total monthly payment which is calculated as $24,000 / 60 months = $400 payment/month. Thus, the principal payment would be $400 - $66.67 = $333.33, each month.

2. Other Consumer Loans

Department stores often offer major appliances on a simple-interest basis for periods of up to one year. So, suppose you buy a refrigerator for $2,000 and pay simple interest at an annual rate of 8%. For 12 months, your monthly payment w💜ould be $180.

This means that you would end up paying a total of $2,088, for a total 澳洲幸运5开奖号码历史查询:interest expense of $160. This is substantially less than what you would have paid in interest expense if you had carried the $2,000 loan f⛎💞or the full year, instead of repaying a portion of it every month.

Important

Investing early is impo🧸rtant for investors because the benefits of compound interest accumulate over time.

3. Certificates of Deposit

A certificate of deposit (CD) is a type of bank investment that pays out a specific amount of money on a set date. You can't withdraw money from a CD until that set date comesꦜ.

If you invest $100,000 in a one-year CD that pays interest at 2% peꦫr annum, you would earn $2,000 in interest income (100,000 x 0.02 x 1) after a year. If the CD pays the same annual interest rate but is only for a s🃏ix-month period, you would earn $1,000 in interest income after six months (100,000 x 0.02 x .5).

4. Discounts on Early Payments

In the business world, suppliers often offer a discount to encourage early paym🦹ent of their invoices.

For example, a $50,000 invoice may offer a 0.5% discount for payment within a month. This works out to $250 for early payment, or an 澳洲幸运5开奖号码历史查询:annualized rate of 6%, which is quite an attractive deal for the 𒆙payer.꧑

How Do You Calculate Simple Interest?

Simple interest can be calculated as SI = P x R x T, where SI = simple interest, P = principal, R = the interest rate, and T = time.

What Is the Difference Between Simple Interest and Compound Interest?

Simple interest is the interest based on the principal amount of the loan and nothing else, regardless of how long the loan term is. Compounded interest is the interest based on the principal 💦amount plus any interest accumulation ♐over time.

What Is the Benefit of Compound Interest?

Compound interest is a faster way to grow money. Not only do you earn interest on🌃 the initial amount invested but you also earn interest on the interest earned on that money every compounding period, which can be daily, weekly, monthly, or annually.

The Bottom Line

Simple interest always works in favor of the borrower because it keeps the total cost 澳洲幸运5开奖号码历史查询:lower ꦯthan if interest was compounded. Simple interest does not benefit investors because it does not take into consideration interest on interest, which makes returns higher. Investors should always look for compounded interest agreements when possible and borrowers should look 𒀰to simple interes💃t when possible.

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