Two Types of Interest

There are two types of interest:


Simple Interest

The formula for simple interest is:

Principal ×  r ×  N years


In the video, both people save $1,000 for 30 years, but John chose a simple interest.

In this example, the principal is $1,000, the interest rate (r) is 10 percent, and the number of years (N) is 30.

How much did John save after 30 years?

$1,000 ×  10%  ×  30 =  $3,000


Compound Interest


The formula for compound interest is:

Principal ×  [(1+r)^N years −  1]


An interest rate (r) is typically noted annually, known as the annual percentage rate (APR).

In the video, both people save $1,000 for 30 years, but Lisa chose a compound interest.

In this example, the principal is $1,000, the interest rate (r) is 10 percent, and the number of years (N) is 30.


How much did Lisa save after 30 years?

$1,000 × [(1+10%)^30−1] = $16,449.4



Time to Practice: Simple and Compound Interest


Think about the answers to the questions below. When you think you have the answer, type it in.

Hint: Use the Compound Interest Calculator to help you with the calculations.


Step 1: Matching Interest Equation Parts

Suppose you want to know how much interest you will earn in five years if you invest $3,000 now with an annual interest rate of four percent. Match the number to its term.

Put the descriptors into the correct empty line

  1. $3,000 = ______
  2. 4% = _____
  3. 5 = _____

rate(r), principal, # of years


Answers:
  1. $3,000 = principal
  2. 4% = rate(r)
  3. 5 = # of years

Step 2: Solving for Simple and Compound Interest

Now solve for simple interest and compound interest.

  1. Simple Interest =  $3,000 ×  4%  ×  5 = _____ $
  2. Compound Interest =  $3,000 ×  [(1 + 4%) ^5 − 1]  ___=

Answers:

  1. 600
  2. 649.96/650
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