Simple Interest
To put it in simple term simple interest is a interest that is charged on the original amount,on that portion of the original amount which remains unpaid.
For example:
A bank gives a 5% simple interest at the end of the year. If i put $1000 in the bank for 2 years, how much will there be at the end of the 2 years?
5% x 1000 = $50 dollars
$1000 + $50 = $1050 (at the end of first year)
$1050 + $50 = $1100 (at the end of 2nd year)
There will be $1100 at the end of 2 years.
**Notice that the 5% interest for the second year is charged on the original amount, $1000, and not the amount of money at the end of the first year, $1050.
Compound Interest
Compound interest is very similar to simple interest; however, with time, the difference becomes considerably larger. This difference is because unpaid interest is added to the balance due. Put another way, the borrower is charged interest on previous interest.
Using the same question as an example:
A bank gives 5% compound interest at the end of the year. If i put $1000 in the bank for 2 years, how much will there be at the end of 2 years?
5% x $1000 = $50
$1000 + $50 = $1050 (at the end of 1 year)
5% x $1050 = 52.5
$1050 + $52.50 = $1102.5 (at the end of 2 years)
There will be $1102.50 at the end of 2 years.
**Notice that the 5% interest for the second year is charged on the final sum of money at the end of the first year, $1050 and not the amount of money at the start of the first year, $1000.
Some things that might use compound or simple interest would be:
1. Bank interest
2. Buying things with installments, with interest charged.
3. Buying insurance
and so on.
Sources:
http://en.wikipedia.org/wiki/Interest
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I like the way you express what basically is compound interest. You have me a clear definition of what is compund interest before giving me an example. This example showed systematic workings which really aided in my understanding. This step by step way of showing your workings is very helpful. I like it.
ReplyDeleteThis post explains interest in detail and give specific examples regarding it, giving us a better understanding on the topic. It also contains tips and many others things that can come in useful
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Lim Jing YU
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