Basic Mathematics Skills:

Simple and Compound Interest

I

F YOU BORROW MONEY to buy a house or a car, you

will probably end up paying interest. In other

words, you will eventually have to pay back the

amount you borrowed, plus an additional fee. There

are different ways to calculate the fee. In this unit,

you will learn the difference between simple and

Key Terms:

Ñ compound interest

principal

rate

simple interest

Calculating Interest

Simple interest is the fee paid on the original loan or deposit. Interest is often referred to

as an annual percentage rate and is the fee paid for the privilege of borrowing money. The fee

is the price paid to spend money today that would typically take time to accumulate.

The formula for calculating simple interest isI=p×r×t.Intheformula, I is interest, p is

Compound interest is interest that is calculated on the principal plus interest. To calcu-

late the compound interest, you must first figure the simple interest and add it to the principal.

Then you calculate the simple interest on the new principal plus interest. Continue com

per period, and n is the number of times

compounded.

Credit card and loan interest is com

pound interest calculated monthly. Mini

mum monthly payments are typically 3

percent of the balance or $20, whichever

principal. Any amount you pay over your required payment will go directly toward the principal on your

loan. By paying off a larger amount of the principal, the amount of interest you owe later will be

reduced. This means your loan will be paid off faster, cutting months or even years of payments off

would those numbers change if you made two extra payments per year?

http://www.bankrate.com/calculators/mortgages/mortgage-calculator.aspx

FIGURE 1. Credit cards often come with high compound interest

rates. Paying only the minimum amount each month likely means

privilege of borrowing money. Simple interest is the fee paid on the original loan or

deposit, and compound interest is the fee paid on the principal plus interest. Credit

card and loan interest is compound interest calculated monthly. You can use formu

-

las to find out how much interest you will have to pay on a loan or how long it will

take to pay off a debt.

Checking Your Knowledge:

2. What are the four variables in the equation for simple interest?

3. How is compound interest calculated?

cards to your best advantage. Some people are able to use credit cards wisely, paying

off the balance each month. Others may avoid using credit at all or may get into

debt that is very difficult to escape. If your parents haven’t already shared their phi

-

losophy on credit cards, ask them to do so. At what age do they think you should be

able to use your own credit card? What mistakes have they made that they hope you

avoid?

Web Links:

: Calculating Interest Rates