The rate at which a lender or financial institution lends money to the borrowers is called simple interest. When you borrow money from such lenders, you are required to pay back an extra amount in addition to the principal amount. The extra money that you pay for using the principal amount for the specified time period is called simple interest. In this blog, we will talk about how to calculate simple interest on a daily, monthly, and yearly basis.
Table of contents
What is Simple Interest?
Simple interest is the straightforward way to calculate the interest applicable on any borrowed amount. The amount of simple interest can be determined by multiplying the applicable daily rate of interest by the borrowed amount (principal) and the number of days between the payments. This type of interest calculation is usually applicable to short term loans and automobile loans. This is highly beneficial to users who make installment payments on time or before time.
Understanding Simple Interest
Simple interest can also be defined as the cost of borrowing money. This is usually expressed in percentage form and is an extra sum that the borrower pays to the lender. When you make installment payments with respect to a simple interest loan, the amount first goes to the simple interest accrued for that time period, and the rest goes to the principal amount. Let’s take a look at an example to understand this concept better:
Example: Suppose Akhil takes a short term loan of Rs. 15,000 at a rate of 5% simple interest charged annually. If the payment is made exactly on the due date, the lender will calculate the interest on the basis of days in the last month. In this scenario, the interest accrued will be Rs. 61.64. However, if the payment is made 10 days before the due date, the lender will charge interest on 20 days only, making the interest for the month Rs. 41.09.
Read Also Compound Interest Calculator, Daily, Monthly, or Yearly
Simple Interest Formula
In this section, we will take a look at the formula for calculating the total accumulated amount after simple interest has been applied:
Total Maturity Amount Value
The formula used to calculate the overall gains accumulated is as follows:
A = P (1 + RT)
Here,
A stands for the total accumulated amount
P stands for the principal amount
R stands for the applicable rate of interest
T stands for the loan tenure
How to Calculate Simple Interest On Deposits
Now that we have seen how simple interest calculations work, let’s take a look at how we can calculate the simple interest on deposits via the below given example:
Example: If you make a Fixed Deposit of Rs. 5,00,000 for a period of 5 years for the interest rate of 10%, the following is what the simple interest calculation will look like:
Simple Interest = 5,00,000 x 10 x 5/100 = Rs. 2,50,000
Total Amount Due at Maturity = 5,00,000 + 2,50,000 = Rs. 7,50,000
This means that you will receive a total amount of Rs. 7,50,000 at maturity of the FD. Out of this, Rs. 2,50,000 is the interest accrued and Rs. 5,00,000 is the original amount.
Read Also Simple Interest vs. Compound Interest & Formula
Difference Between Compound Interest and Simple Interest
Given below are some of the differences between simple and compound interest:
| Points of Parity | Simple Interest | Compound Interest |
| Definition | Simple interest is the interest calculated on the original principal amount for the entire tenure. | Compound interest is accumulated throughout the tenure periodically and added to the original principal amount. |
| Treatment of Principal Amount | The principal amount remains the same during the entire tenure. | The principal amount and compound interest is subject to change throughout the tenure. |
| Returns | Simple interest returns tend to be generally low. | Compound interest provides comparatively higher returns. |
| Purpose | Simple interest is beneficial when you are borrowing money or taking a loan. | Compound interest can work in your favor if you are depositing or investing your money. |
| Formula | Simple Interest = P x R x T | Compound Interest = P x (1+r) t – P |
FAQs about Simple Interest
Q1. What does the term ‘rate’ mean in simple interest?
The term ‘rate’ in simple interest is the rate at which interest is calculated when you have lent someone money or made any investments.
Q2. Is interest accumulation slow when simple interest is applied?
Yes, the accumulation of interest is slow when the amount is calculated using simple interest.
Q3. Does the principal amount stay the same during the loan/investment period during simple interest?
Yes, the original principal amount remains the same during every instance of interest calculation when simple interest is used.
