Simple interest is charged only on the principal. Interest that has already been earned or owed does not itself earn more interest, so the amount added each year stays constant and the total grows in a straight line. It contrasts with compound interest, where interest is added to the balance and then earns interest too.
The term also has a lending meaning. For auto loans the CFPB describes simple interest as calculating interest on the outstanding balance of the loan, daily or monthly, as opposed to precomputed interest, where the total interest is set at the start.
Formula
I = P × r × t
- I: interest in dollars.
- P: principal.
- r: annual rate as a decimal (5% = 0.05).
- t: time in years (months ÷ 12, days ÷ 365).
OpenStax gives the future value as FV = P + I.
Example
$2,500 at 4.5% for 3 years: 2,500 × 0.045 × 3 = $337.50 of interest, so the total is $2,837.50. Over 10 years, $10,000 at 5% earns $5,000 of simple interest, versus $6,288.95 with annual compounding.
The simple interest formula guide covers solving for rate, time or principal, and the interest calculator compares simple and compound results.
Common mistakes
- Using months or days as t without converting to years.
- Entering the rate as 5 instead of 0.05.
- Expecting a savings account or credit card balance to follow simple interest when it compounds.