Chapter 7: Ratios, Proportions, and Percentages 93The amount borrowed or invested is the principal, and the percent of that principal that will
be charged (or paid) in interest every year is the rate, sometimes called the APR, for annual
percentage rate. To find the total interest on a loan or investment, you multiply the principal
times the rate times the time, measured in years. The formula for simple interest is I = Prt, where
I stands for interest, P for principal, r for rate, and t for time.
DEFINITION
Interest is money you pay for the use of money you borrow or money you receive
because you’ve put your money into a bank account or other investment.
The principal is the amount of money borrowed or invested. The rate is the percent
of the principal that will be paid in interest each year.Imagine that you open a new bank account with a deposit of $4,500, and the bank pays 1.5
percent interest per year. You leave that money in the account and don’t add any money to it or
take any money out for a total of 6 years. How much interest will you earn? And how much will
be in your account after those 6 years?
Use the formula I = Prt, with I as the interest, P as the principal or amount you deposited, and
t as 6, the time in years. Take the rate of 1.5% per year and change the percent to a fraction or
decimal. You will earn I = 4,500 v 0.015 v 6 = 405. You’ll earn $405 interest, which will be
added to your $4,500, so that after 6 years you’ll have $4,905.
WORLDLY WISDOM
The I = Prt formula is the calculation of simple interest. Many banks pay what’s called
compound interest. They calculate your interest every year (and sometimes more
often) and add it to your account. The next year, if you don’t disturb the money, you
get interest on your original principal and on the interest. It goes on like that over
and over, and each time interest is calculated you have a little more money in the
bank, and you get a little bit extra interest. Over time, it can amount to quite a bit of
extra money. The formula for compound interest is quite a bit more complicated and
requires exponents.If you want to plan for a special event, you might want to know how much you should deposit to
earn enough interest to pay for your vacation three years from now. Or you might want to know
how long it would take to earn a certain amount of interest. Those questions can be answered
with the same simple interest formula, but a slightly different calculation.