A promissory note is a financial and legal instrument through which one party agrees (or promises) to pay another party a sum of money that's comprised of two pieces: principal and interest. These handy documents lay the groundwork for much of day-to-day capitalism, spelling out terms on everything from auto loans, to home mortgages, to notes payable and receivable between corporations.

That's why as the payee, you'll want to be crystal clear on the amount of interest you're committing to pay for any promissory note that you sign. That calculation is a simple three-step process.

## 1. Gather the information

First collect the information you'll need, which should all be readily available on the note itself. To calculate the total interest liability you need three numbers: the *principal*, the *interest rate*, and the *time period*. For example, let's say your note carries principal of $5,000 at an annual rate of 7% for a time period of three years.

## 2. Calculate interest for one year

Next, calculate the interest charge for one year by multiplying the principal by the interest rate. In our example that math would yield $5,000 X 0.07 = $350. This is the annual interest charge for the note.

## 3. Calculate interest for the entire period

Finally, to get the full cost you need to multiply the annual charge by the number of years specified in the promissory note. In this case the calculation would show $350 (charge for 1 year) X 3 (total years) = $1,050. Note that this total is 21% of the principal, equating to three 7% annual charges.

You can perform the same calculation using partial-year periods simply by converting the time period into fractions of a year. For example, here's how the math would look for a six-month, or half year, $1,000 loan at 10% annual interest:

$1,000 (principal) X .10 (interest rate) X 0.5 (time period in years) = $50

At the end of this six-month period you'd be on the hook for the $1,000 principal you borrowed, plus $50 of interest charges.

**The $15,834 Social Security bonus most retirees completely overlook**

If you're like most Americans, you're a few years (or more) behind on your retirement savings. But a handful of little-known "Social Security secrets" could help ensure a boost in your retirement income. For example: one easy trick could pay you as much as $15,834 more... each year! Once you learn how to maximize your Social Security benefits, we think you could retire confidently with the peace of mind we're all after.

*This article is part of The Motley Fool's Knowledge Center, which was created based on the collected wisdom of a fantastic community of investors. We'd love to hear your questions, thoughts, and opinions on the Knowledge Center in general or this page in particular. Your input will help us help the world invest, better! Email us at knowledgecenter@fool.com. Thanks -- and Fool on!*