# 7.1: Simple Interest

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Discussing interest starts with the **principal**, or amount your account starts with. This could be a starting investment, or the starting amount of a loan. Interest, in its most simple form, is calculated as a percent of the principal. For example, if you borrowed $100 from a friend and agree to repay it with 5% interest, then the amount of interest you would pay would just be 5% of 100: $100(0.05) = $5. The total amount you would repay would be $105, the original principal plus the interest.

Simple One-time Interest

*I* is the interest

*A* is the end amount: principal plus interest

*P0* is the principal (starting amount)

*r* is the interest rate (in decimal form. Example: 5% = 0.05)

### Example 1

A friend asks to borrow $300 and agrees to repay it in 30 days with 3% interest. How much interest will you earn?

*P0* = $300 the principal

*r* = 0.03 3% rate

*I* = $300(0.03) = $9. You will earn $9 interest.

One-time simple interest is only common for extremely short-term loans. For longer term loans, it is common for interest to be paid on a daily, monthly, quarterly, or annual basis. In that case, interest would be earned regularly. For example, bonds are essentially a loan made to the bond issuer (a company or government) by you, the bond holder. In return for the loan, the issuer agrees to pay interest, often annually. Bonds have a maturity date, at which time the issuer pays back the original bond value.

### Example 2

Suppose your city is building a new park, and issues bonds to raise the money to build it. You obtain a $1,000 bond that pays 5% interest annually that matures in 5 years. How much interest will you earn?

Each year, you would earn 5% interest: $1000(0.05) = $50 in interest. So over the course of five years, you would earn a total of $250 in interest. When the bond matures, you would receive back the $1,000 you originally paid, leaving you with a total of $1,250.

We can generalize this idea of simple interest over time.

Simple Interest over Time

*I* is the interest

*A* is the end amount: principal plus interest

*P0* is the principal (starting amount)

*r* is the interest rate in decimal form

*t* is time

The units of measurement (years, months, etc.) for the time should match the time period for the interest rate.

APR – Annual Percentage Rate

Interest rates are usually given as an **annual percentage rate (APR)** – the total interest that will be paid in the year. If the interest is paid in smaller time increments, the APR will be divided up.

For example, a 6% APR paid monthly would be divided into twelve 0.5% payments.

A 4% annual rate paid quarterly would be divided into four 1% payments.

### Example 3

Treasury Notes (T-notes) are bonds issued by the federal government to cover its expenses. Suppose you obtain a $1,000 T-note with a 4% annual rate, paid semi-annually, with a maturity in 4 years. How much interest will you earn?

Since interest is being paid semi-annually (twice a year), the 4% interest will be divided into two 2% payments.

*P0* = $1000 the principal

*r* = 0.02 2% rate per half-year

*t* = 8 4 years = 8 half-years

*I* = $1000(0.02)(8) = $160. You will earn $160 interest total over the four years.

### Try it Now 1

A loan company charges $30 interest for a one month loan of $500. Find the annual interest rate they are charging.

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