Refresher Course 101: Simple Interest

Before we dive into formulas, let’s review some basic calculations, including the equation for calculating simple interest. Because money has time value, we apply interest as the basic equalizer. Simple interest calculations account for the time value by raising the principal to a higher number. Calculating interest is a very basic and commonly understood process, but understanding the equation can lead to a number of other helpful determinations.

Let’s begin with the basic simple interest formula. Assume that a client has borrowed $10,000 for six months at an annual interest rate of 5%. The question is: what will the client pay in interest on the principal of $10,000, over a six-month period, at an interest rate of 5% per year?

The formula is:

I = P  x  i  x  n

I = interest

P = principal

i = interest rate (per month)

n = number of months

To calculate simple interest, we simply multiply principal by interest rate by the number of months (or other time periods) during which the loan remains open.

Here’s the math:

I = P  x  i  x  n

I = $10,000  x  5%  x  6/12  (6 months in a 12-month period, since the interest rate is annual)

I = $10,000  x  0.05  x  0.5

I = $250

Thus, the client will pay $250 in simple interest on a $10,000 loan at 5% over 6 months. The client will have repaid the loan principal and interest in the total amount of $10,250.

Interest on Overdue Settlement

Let’s apply the simple interest calculation to another scenario. Let’s assume that $10,000 was the settlement reached in an employment dispute. Three months after the settlement is reached, however, the employer has failed to remit payment of settlement funds. The Plaintiff’s lawyers allow for a reasonable 30-day waiting period but claim that three months is unreasonable. They are now seeking two months’ interest on the $10,000 settlement, based on an annual interest rate of 3%. Here’s the formula:

I = P  x  i  x  n

I = $10,000  x  3%  x  2/12

I = $10,000  x  0.03  x  0.1667

I = $50.01

Thus, the employer will now be required to pay $10,050.01, assuming there are no further delays in tendering payment of the settlement funds.

Share this Post