Sometimes, when we borrow a dress for our school function, we have to pay rent for the duration of the time we use that dress. Also, in old times, people used to pay rent in order to use a movie player on per day basis. Similarly, when you put your money in a bank, the bank pays you a rental fee on the deposited money. So we can say it costs MONEY to BORROW money.
What is the cost of borrowing or borrowing interest rate?
When we borrow money, we usually pay money for using that money. An interest is charged as a percent (per year) of the sum borrowed. It can also be defined as follows:
Let Ram borrow money from Sneha for a certain time period, after the completion of time period, he returns the borrowed money and also pay some extra or additional money. This extra money that Ram Paid to Sneha is called interest. The money Ram borrowed from Sneha is known as Principal. Interest is computed as a % of Principal & this % is called Rate of interest.
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Understanding Simple Interest
There is well known fact about Rate of interest, which is always assumed to be Per annum. For example 10% rate of interest Per annum.
Let us understand these definitions better and go through the simple interest formula:
- Suppose Diya invests Rs. 1000 in a bank. The bank says “10% interest”. It means the bank will pay an amount increased by 10% after 1 year.
Interest = Rs. 1000 × 10% = Rs. 100. So, the increased amount after one year = Rs. 1000 + Rs. 100 = Rs. 1100.
- What if Diya invests the money for 2 years?
Interest for first year = Rs. 1000 × 10% = Rs. 100
Interest for second year = Rs. 1000 × 10% = Rs. 100
Total interest = (Rs. 1000 × 10%) + (Rs. 1000 × 10%) = Rs. 1000 × 10% × 2 = Rs. 200
Here, Rs. 1000 is the Principal (P), 10% is the percentage increase or interest rate (R), 2 is the time period (T).
Therefore, the general formula for simple interest (S.I.) is SI = P × R × T/100.
Now, the total money that Diya will get after 2 years will be Rs. 1000 + Rs. 200 = Rs. 1200. The sum of money which Diya will get back is called amount.
So, Amount = Principal + Interest.
As per the formula of simple interest = P × R × T/100. This can be further written as S.I. × 100 = P × R × T. Now here if any of the three components on the Right hand side is missing, then Interest × 100 can be divided by the other two components to find the third one e.g. the formula for calculating the time becomes (Interest × 100)/(Principal × Rate). Similarly the rate/principal can be calculated. These concepts are useful in solving simple interest problems.