Simple interest and compound interest are interest calculating methods used widely in banking and financial organizations. In simple interest, the principal amount is the same every year, while in compound interest, the amount at the end of one year is the principal amount for the next year. Let us explore more differences between simple interest and compound interest.

Mohit pays Rs 9000 as an amount on the sum of Rs 7000 that he had borrowed for 2 years. Most bank deposit accounts, credit cards, and some lines of credit will tend to use compound interest. Now suppose you take out the same loan, with the same terms, but the interest is compounded annually. When the loan is due, instead of owing $13,000, you end up owing $13,310.

- It does not involve compounding, where borrowers end up paying interest on principal and interest that grows over multiple payment periods.
- Simple interest is the cost of using or borrowing money without compound interest or interest on interest.
- On the consumer side, borrowing money that charges simple interest benefits you because it will cost you less than compound interest.
- Simple interest is a method of interest that always applies to the original principal amount, with the same rate of interest for every time cycle.

This calculator allows us to enter the values of principal, rate of interest, and time duration (in years/months/days) and finds the simple interest showing step-by-step solution. Simple interest is used in cases where the amount that is to be returned requires a short period of time. So, monthly amortization, mortgages, savings calculation, and education loans https://www.wave-accounting.net/ use simple interest. A loan is an amount that a person borrows from a bank or a financial authority to fulfil their needs. Loan examples include home loans, car loans, education loans, and personal loans. A loan amount is required to be returned by the person to the authorities on time with an extra amount, which is usually the interest you pay on the loan.

## Example: Alex borrows $1,000 for 5 Years, at 10% simple interest:

In ordinary simple interest, a year is considered of 365 days while calculating the interest while in exact simple interest, a year is considered 366 days if it is a leap year. Both methods use the same formula to calculate simple interest. Now, we can also prepare a table for the above question adding the amount to be returned after the given time period. Namita borrowed Rs 50,000 for 3 years at the rate of 3.5% per annum. Simple interest usually applies to automobile loans or short-term personal loans. In the U.S., most mortgages on an amortization schedule also involve simple interest, although they can certainly feel like compound interest loans.

That comes out to $1,000 per year, which totals $3,000 in interest over the life of the loan. Simple interest is an interest charge that borrowers pay lenders for a loan. It is calculated using the principal only and does not include compounding interest.

Simple interest does not benefit investors because it does not take into consideration interest on interest, which makes returns higher. Investors should always look for compounded interest agreements when possible and borrowers should look to simple interest when possible. This means that you would end up paying a total of $2,088, for a total interest expense of $160. This is substantially less than what you would have paid in interest expense if you had carried the $2,000 loan for the full year, instead of repaying a portion of it every month. As the outstanding loan balance diminishes every month, the interest payable reduces, which means a greater part of the monthly payment goes toward the principal repayment. Car loans are amortized monthly, which means that a portion of the loan goes to pay the outstanding loan balance every month, and the remainder goes toward the interest payment.

## Simple Interest: Definition, Formula, Solved Examples, Facts

Adam received his master’s in economics from The New School for Social Research and his Ph.D. from the University of Wisconsin-Madison in sociology. He is a CFA charterholder as well as holding FINRA Series 7, 55 & 63 licenses. He currently researches and teaches economic sociology and the social studies of finance at the Hebrew University in Jerusalem.

## How to calculate simple interest

For the following 4 years, the value of the house decreases in value by a simple interest rate of 0.18\% per annum. For the first 3 years, the value of the house increases by the rate of simple interest of 0.2\% per year. Find the total amount received by Michael if he invested wave life sciences ltd a principal amount of $\$3000$ and receives $\$1500$ as interest. Imagine you lend $\$1,000$ to your friend, and they agree to pay you back with a $5\%$ interest rate per year. With simple interest, the interest remains the same every year, and it doesn’t “grow” over time.

Note that the interest rate (5%) appears as a decimal (.05). To do your own calculations, you will need to convert percentages to decimals. For example, to convert 5% into a decimal, divide five by 100 to get .05.

Simple interest is used to calculate growth or decay, in terms of money. For example, you can use it to calculate the interest charges based on a loan amount or it can be used to calculate the amount of interest you can earn if you invest your money. For example, calculate the interest earned on \$3,000 with a simple interest rate of 5\% over 2 years.

CAGR is extensively used to calculate returns over periods for stocks, mutual funds, and investment portfolios. CAGR is also used to ascertain whether a mutual fund manager or portfolio manager has exceeded the market’s rate of return over a period. An investment with an 8% annual rate of return will double in nine years (72 ÷ 8%).

Simple Interest (S.I) is the method of calculating the interest amount for some principal amount of money. Have you ever borrowed money from your siblings when your pocket money is exhausted? You use that money for the purpose you had borrowed it in the first place.

## Example \(\PageIndex2\): Simple Interest — Using the Formula

By contrast, most checking and savings accounts, as well as credit cards, operate using compound interest. Simple interest works in your favor as a borrower, since you’re only paying interest on the original balance. That contrasts with compound interest, where you also pay interest on any accumulated interest. For example, let’s say you take out a $10,000 loan at 5% annual simple interest to repay over five years. You want to know your total interest payment for the entire loan.

## How Much does it Cost to Borrow Money?

Typically expressed as a percentage, it amounts to a fee or charge that the borrower pays the lender for the financed sum. Generally, all banks, financial institutions, and other money-lending companies apply compound interest on the loans as in this way they will earn will more interest from the customers. The calculations of compound interest are difficult and require a lot of calculation which is difficult for the common people to do. When a person acquires a loan from a bank, he or she is required to repay the principal borrowed plus the interest amount and the total amount repaid is referred to as the Amount. Get the magic of compounding working for you by investing regularly and increasing the frequency of your loan repayments.