Legal Definitions - simple interest

Simple interest is a method of calculating interest where the interest amount is determined solely based on the original principal sum of a loan or investment. This means that interest is only earned or charged on the initial amount borrowed or invested, and not on any accumulated interest from previous periods. The interest amount remains constant over the life of the loan or investment, provided the principal amount does not change.

Here are some examples to illustrate simple interest:

• Example 1: A Short-Term Personal Loan

  Imagine David borrows $2,000 from a family member to cover an unexpected expense, agreeing to pay it back in one year with a 4% simple annual interest rate. Each month, or at the end of the year, the interest is calculated only on the original $2,000. The interest for the year would be $2,000 * 0.04 = $80. David would repay the original $2,000 plus $80 in interest, totaling $2,080. If the loan were for two years under the same terms, the interest would simply be $80 per year, totaling $160 over two years, because the interest calculation always refers back to the initial $2,000 principal.

  This example demonstrates simple interest because the interest charged ($80) is consistently calculated only on the initial principal amount ($2,000), without factoring in any interest that might have accumulated in previous periods.

• Example 2: A Certificate of Deposit (CD)

  Sarah invests $10,000 in a 3-year Certificate of Deposit (CD) that offers a 2.5% simple annual interest rate. With simple interest, she will earn $10,000 * 0.025 = $250 in interest each year. Over the three-year term, she will earn a total of $250 * 3 = $750 in interest. At the end of the three years, she will receive her original $10,000 investment back, plus the $750 in accumulated simple interest.

  This illustrates simple interest because the annual interest earned ($250) is always based on the initial $10,000 investment. The interest earned in the first year does not become part of the principal for calculating interest in the second or third year.