How to Calculate Simple Interest

Simple interest is calculated with one formula: I = P × r × t. P is the principal, the amount you start with; r is the annual interest rate written as a decimal; and t is the time in years. Multiply the three together and you have the interest.

For example, $1,000 at 5% for 3 years earns 1000 × 0.05 × 3 = $150 in interest, for a final balance of $1,150. To turn a percentage into the decimal r, divide by 100 — 5% becomes 0.05.

The defining feature of simple interest is that it's always calculated on the original principal, never on interest already earned. So each year adds the same fixed amount — $50 a year in the example above — and the balance climbs in a straight line.

That makes it easy to predict and easy to do in your head, which is why it's used for many short-term arrangements where the simplicity is worth more than squeezing out extra growth.

Compound interest, by contrast, is calculated on the principal plus the interest accumulated so far, so it earns interest on interest and grows faster over time. Over long periods the gap between the two becomes large.

You'll typically meet simple interest on many car loans, some personal and short-term loans, and certain bonds, while savings accounts, credit cards, and mortgages generally use compound interest. When the time is short, the two are close; the longer the term, the more compounding pulls ahead.