10.2 Personal Loans and Simple Interest 595 Consider the following dilemma. Your car breaks down and the mechanic tells you that the repairs will cost $450. You currently do not have the $450, but your family desperately needs to have a car. One option for you would be to borrow the money from a friend, a family member, a bank, or other lending institution. In this section, we will discuss personal loans and the cost of obtaining such loans. Personal Loans and Simple Interest SECTION 10.2 LEARNING GOALS Upon completion of this section, you will be able to: 7 Use the simple interest formula to calculate ordinary interest. 7 Use the United States rule to solve simple interest problems. Why This Is Important If you need to borrow money, you may need to consider different options for your loan. Understanding the cost of borrowing money is an important part of financial literacy and will help you make informed decisions about your personal finances. The money a bank or other lender is willing to lend you is called the amount of credit extended or the principal of the loan. The amount of credit and the interest rate that you may obtain depend on the assurance you can give the lender that you will be able to repay the loan. Your credit is determined by your reputation for repaying loans, by your earning power, and by what you can pledge as security to cover the loan. Security (or collateral) is anything of value pledged by the borrower that the lender may sell or keep if the borrower does not repay the loan. Acceptable security may be a business, a mortgage on a property, the title to an automobile, savings accounts, or stocks or bonds. Bankers sometimes grant loans without security, but they require the signature of one or more other persons, called cosigners, who guarantee the loan will be repaid. For either of the two types of loans, the secured loan or the cosigner loan, the borrower (and cosigner, if there is one) must sign an agreement called a personal note. This document states the terms and conditions of the loan. The most common ways for individuals to borrow money are through an installment loan or using a credit card. (Installment loans and credit cards are discussed in Section 10.4.) The concept of simple interest is essential to the understanding of installment buying. Interest is the money the borrower pays for the use of the lender’s money. One type of interest is called simple interest. Simple interest is based on the entire amount of the loan for the total period of the loan. The formula used to determine simple interest follows. Simple Interest Formula i prt Interest principal rate time = × × = In the simple interest formula, the principal, p, is the amount of money borrowed (or loaned), the rate, r, is the rate of interest expressed as a decimal number, and the time, t, is the number of days, months, or years for which the money will be lent. When using the simple interest formula, time must be expressed in the same period as the rate. For example, if the rate is 2% per month, the time must be expressed in months. Typically, rate means the annual rate unless otherwise stated. Principal and interest are expressed in dollars in the United States. The effective date of a loan is the date on which the borrower receives the money from the lender. The maturity date of the loan is the date on which the principal and interest are required to be paid by the borrower to the lender. Nejron Photo/ Shutterstock
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