Simple Interest vs. Compound Interest & Formula

When you borrow money from a bank, financial institution or lender, an extra amount is charged on the total amount that you borrow. This additional amount is referred to as an Interest Rate. This interest can be of two kinds – Simple Interest and Compound Interest. 

While a simple interest is charged on the principal loan amount, compound interest is charged on the principal loan amount as well as the accumulated interest. The difference between the two does not just end here, there’s a lot more to know before you take a loan. Let’s dig deeper and help you get a better loan deal.  

Compound Interest and Simple Interest – Basic Definition

Before we get down to the differences, let’s understand the basic definition of the compound and simple interest. Getting a grasp on that will make calculating these interests less complicated for you. 

Simple Interest

Simple interest is calculated as a percentage of the principal amount on a yearly basis. In simple words, it is a fixed amount that a person pays at regular intervals on the original loan taken. Most borrowers opt for this type of interest because if at any point in time they pay more than the fixed amount, the amount that they pay going forward automatically decreases. 

Compound Interest

The interest that you pay on the sum of the initial principal and the interest accrued from the previous periods is known as compound interest. Simply put, it is an ‘interest on interest’ which is computed on the changes in each period and not on a fixed principal amount. 

Compound Interest vs Simple interest – Key Differences

Read the following points to differentiate between both interest types

• Simple interest is charged only on the principal loan amount whereas compound interest is based on both the principal as well as the previously accrued interest. 
• Compared to simple interest, compound interest offers higher returns
• The principal amount in simple interest is fixed. In the case of compound interest, however, the principal loan amount keeps changing. 
• A simple interest’s growth rate is low compared to compound interest.
• When it comes to calculation, simple interest is easy and compound interest is complicated. 
• The effects of these interests have opposite effects on lenders and borrowers. While lenders consider Compound interest as beneficial, borrowers prefer simple interest. 

Difference Between Simple Interest and Compound Interest

If you want to understand the difference between simple interest and compound interest at a glance, here’s a table for you: 

Compound Interest vs Simple Interest Formula

To get a clear understanding of how compound and simple interest work, you need to know their formulas. The simple interest and compound interest formulas are as follows: 

Simple Interest = (P × R × T) ⁄ 100 

Compound Interest = P(1+R/100)ᵗ − P

Formula Notations: 

P = Principal Amount

T = Time (in years)

R = Rate of Interest p.a

Compound Interest Vs Simple Interest – Examples

Now that you know the basic difference and formula of simple and compound interest, check out these examples. They will give you a better grasp of loan interests and make decision making easier.

Example 1: Calculate the compound interest and the simple interest on ₹80,000 for 3 years at 20% p.a.

Solution: 

S.I. = (P × R × T) ⁄ 100 and C.I.= P(1+R/100)ᵗ − P

Principal = ₹80,000 , Time(t) = 3 years , Rate of Interest (R) = 20%

S.I. = ₹(80,000 × 20× 3) / 100 = ₹48,000

C.I.= P(1+R/100)t − P = ₹80,000 (1 + 20/100)³ –  80,000]

C.I. = ₹[1,38,240 – 80,000] = ₹58,240

Example 2: Calculate the difference between simple interest and compound interest on ₹1,00,000 for 3 years at 7% p.a.

Solution: 

S.I. = (P × R × T) ⁄ 100 and C.I.= P(1+R/100)ᵗ − P

Principal = ₹1,00,000 , Time(t) = 3 years , Rate of interest (r) =7%

S.I. = ₹(1,00,000 × 7 × 3) / 100 = ₹21,000

C.I.= P(1+R/100)t − P = ₹[1,00,000 (1 + 7/100)³ –  1,00,000]

C.I. = ₹[1,22,504.3- 1,00,000] = ₹22,504.3

Difference (C.I.- S.I.) = ₹22,504.3 – ₹21,000 = ₹1,504.3

Use a Compound Interest v/s Simple Interest Calculator

If you are not sure whether to opt for simple interest or compound interest, you can compare the interest rates using a compound interest vs simple interest calculator. Multiple calculators are available online and only require you to follow these steps:

Simple Interest

1. Type the principal amount 
2. Enter the yearly interest rate (%)
3. Type the time duration/period (no. of years)
4. Click on Submit

Compound Interest

1. Select the Compound Frequency (daily, weekly, monthly, quarterly, semi-yearly, or yearly) 
2. Type the principal amount 
3. Then type the yearly interest rate (%)
4. Enter the time duration/period unit (no. of years)
5. Click on Submit

Note – Some online calculators also allow you to choose different period units such as days, weeks, months, quarters, and years. Just select your preferred period unit from the options available. 

Benefits of Using Compound Interest and Simple Interest Difference Calculator

The advantages of using a compound interest and simple interest calculator include:

• You don’t have to worry about manually calculating the simple interest and compound interest of your loan amount.
• You will be able to find the difference between simple interest and compound interest, accurately and within seconds. 

FAQ’s about Difference Between Simple Interest and Compound Interest