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Tuesday, February 5, 2013

Simple interest



Definition:
Consider a house that one would have rented. The tenant has to pay some amount of money to the owner of the house as rent for using the property. Similarly if a person borrows money from another person, he has to pay some amount of money as rent for using the borrowed money. This charge paid for use of funds is called interest. Therefore the amount charged on a fixed amount of principal, that is lent by a lender for a specific period of time is called simple interest. In simple interest the principle amount over the period of loan remains constant and is not reduced or increased.
Formula for simple interest:
Some important terms related to simple interest:
(1) Principal (P): The money borrowed or lent.
(2) Interest (I): The additional amount paid to the lender, for the use of the money borrowed.
(3) Rate( R ): Interest for one year per 100 units of currency.
(4) Time (T): The time period for which the money is borrowed.
(5) Simple interest or (S.I.): When the interest is paid to the lender regularly every year or every half year, we call the interest simple interest.
(6) Amount (A): Principal + Interest = amount at the end of the term of T years.

Formula used for calculating simple interest is like this:
S.I. = P x R x T
100
A = P + S.I.

When we calculate simple interest, the following points need to be noted:
(1) Rate of 4% per annum means $ 4 for every $ 100 per year. Similarly a rate of 1.5% per month means $ 1.5 for every $ 100 per month = $ 1.5 * 12 = $ 18 for every $ 100 per  year = 18% per annum.
(2) When time is given in days, we convert it to years by dividing by 365. When time is given in  months, we convert it to years by dividing by 12. When dates are given, the day on which the sum is borrowed is not included but the day on which the money is returned is included, while counting the number of days.


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