1. The Anatomy of the SI Formula (I = PRT)
To master simple interest, you must understand its three core components:
- Principal (P): The initial amount of money borrowed or invested.
- Rate (R): The annual interest rate, always converted to a decimal (e.g., 5% = 0.05).
- Time (T): The duration in years. For months, divide by 12; for days, divide by 365 (or 360).
2. Ordinary vs. Exact Simple Interest (Banker's Rule)
In the financial world, "Time" can be calculated in two ways:
- Ordinary Interest (Banker's Rule): Uses a 360-day year (12 months of 30 days). This is common in commercial loans.
- Exact Interest: Uses the actual 365-day year (or 366 in leap years). This is common in government and long-term federal loans.
3. Simple vs. Compound Interest
The primary difference is that simple interest is calculated only on the principal, while compound interest is calculated on the principal plus the interest that has already been added.
| Feature | Simple Interest | Compound Interest |
|---|---|---|
| Calculation Base | Original Principal only | Principal + Accumulated Interest |
| Growth Rate | Linear (Static) | Exponential (Accelerating) |
| Common Use | Consumer Loans, CDs | Savings, Credit Cards, Mortgages |
4. Solving for Other Variables
Need to find how long it will take to earn $500? Rearrange the formula:
- Find Principal: P = I / (r × t)
- Find Rate: r = I / (P × t)
- Find Time: t = I / (P × r)