Doing Simple Interest Calculations Extracted from regular lecture notes by Dr. B. C. Paul This slide show is copyrighted in 2007.

Simple Interest or Simply _ _ _ _ _ _ _  Is a special type of Loan known as a Simple Interest or Add Interest Loan  Main Places Found  Sleezy Finance Houses (such as Herby’s Sleezy Money Finance Company)  Auto Loans  Most that come from Car Dealers  A lot of Car Loans from Banks

Calculating Simple Interest  Interest Rate is Reported on an annual basis  There is no compounding or interest charged on interest  You still need to get the period interest rate by dividing by number of payments per year  If Sleezy money charges 7.5% with monthly payments for 5 years  Period Interest Rate is 7.5/12 = 0.625%  Still need to convert to decimal for calculation

The Trick  Interest is charged as one lump sum  Loan Amount * Period Interest Rate * Number of payments = Interest  For Herby 5000 * * 60 = $1,875  The Interest is then added to loan immediately  Ie Herby’s loan is for $5,000 + $1,875 = $6,875  (Can see why they are called Add Interest Loans)

Calculating Payments  Loan amount with interest added is just divided by number of payments  For Herby $6,875 / 60 = $114.58

Whats Wrong with That?  Notice that you paid full interest rate on all the money that you borrowed even after you have paid the money off  If Herby tries to pay a simple interest loan off the next month he’ll still pay $6,875 or full interest for 5 years

The Impact Herby’s interest rate Starts at 7.5% but Climbs over time to 450% Herby’s regular Bank loan costs $1,177 in interest Herby’s Simple Interest Loan will Cost $1,875 (half again as Much)

The Deception  Auto Dealers and Some Finance Houses quote attractive interest rates  Only in the fine print is simple interest disclosed  Herby’s 7.5% Simple interest loan is equivalent of 11.5% of a regular compound interest loan  Allows organizations to quote far lower rates than competition