Simple interest is a method of calculating the interest that is charged on fixed deposits, savings accounts, and loans. It is calculated on the principal amount. Simple interest does not add any interest rate on the interest amount gathered on the principal amount.
Where Is the Concept of Simple Interest Used?
Simple interest may be used in the following financial situations:
- Borrowing money: In the case of a loan, you will need to pay interest on the amount you have borrowed.
- Lending money: In the case of a savings account, fixed deposit , or recurring deposit, you will receive the amount in the form of interest on your principal.
However, banks, financial institutions, and professional lenders in India do not use simple interest. They use compound interest instead.
Simple Interest Formula
The formula for calculating simple interest is:
(P x r x t) ÷ 100
P = Principal
r = Rate of Interest
t = Term of the loan/deposit in years
This means that you are multiplying the principal amount with the rate of interest and the tenure of the loan or deposit. Make sure you enter the tenure in years and not months. If you are entering the tenure in months, then the formula will be:
(P x r x t) ÷ (100 x 12)
If you want to find the total amount – that is, the maturity value of a deposit or the total amount payable including principal and interest, then you can use this formula:
FV = P x (1 + (r x t))
Here, FV stands for Future Value. To get the interest payable or receivable, you can subtract the principal amount from the future value.
Let's give you some examples to understand how much you will earn on your deposits, or how much you will have to pay on your loan if your bank uses simple interest.
Simple Interest Calculation in Deposits
Example 1: If you invest Rs.50,000 in a fixed deposit account for a period of 1 year at an interest rate of 8%, then the simple interest earned will be:
(50,000 x 8 x 1) ÷ 100 = Rs.4,000
The interest you will receive at the end of the 1-year tenure will be Rs.4,000. Therefore, the maturity amount of the FD will be Rs.54,000.
Example 2: If you invest Rs.8 lakh in a fixed deposit account for a period of 5 years at an FD interest rate FD interest rate of 6.85%, then the simple interest earned will be:
(8,00,000 x 6.85 x 5) ÷ 100 = Rs.2,74,000
The interest you will receive at the end of the 5-year tenure will be Rs.2.74 lakh. Therefore, the maturity amount of the FD will be Rs.10.74 lakh.
Simple Interest Calculation in Loans
Example 1: Say you borrowed Rs.5 lakh as personal loan from a lender on simple interest. The interest rate is 18% and the tenure is 3 years. The interest you will end up paying to the bank will be:
(5,00,000 x 18 x 3) ÷ 100 = Rs.2,70,000
The interest you will be paying over the period of 3 years will be Rs.2.7 lakh. Therefore, the total repayment you will make to the bank will be Rs.7.7 lakh. On a monthly basis, this would come up to around Rs.21,389.
Example 2: Say you took a car loan on simple interest. The principal amount is Rs.12 lakh, the interest rate is 7%, and the tenure is 5 years. The interest you will end up paying will be:
(12,00,000 x 7 x 5) ÷ 100 = Rs.4,20,000
The interest you will be paying over the period of 5 years will be Rs.4.2 lakh. Therefore, the total repayment you will make will be Rs.16.2 lakh. On a monthly basis, this would come up to around Rs.45,000.
Difference Between Simple and Compound Interest
Simple Interest |
Compound Interest |
It is calculated on the total principal amount for the entire tenure. |
It is calculated on the principal amount periodically (monthly, quarterly, half-yearly or annually). |
The accumulated interest on the principal is not added to the calculation of interest for the next period. |
The interest that you accumulate periodically is added to the calculation of interest for the next period. |
The interest earned/paid will not increase even if the calculation is done periodically. |
The interest earned or paid will increase if the frequency of interest generation or payment is more. |
The accumulation of interest is slow. |
The accumulation of interest is fast since you get interest on the growing interest amount as well. |
Simple interest will not earn you enough for savings and investments but will benefit you if you take a loan. |
Compound interest will earn you more in savings and investments but will be costlier on a loan. |
It is not good for wealth creation. |
It is good for wealth creation. |
It is beneficial to the borrower but not to the lender. You will be paying less on a loan that is taken on simple interest. |
It is beneficial to the lender but not to the borrower. You will be paying more on a loan that is taken on compound interest. |
Simple interest is easy to calculate. |
Compound interest is complicated to calculate. |
If you get any loan offered with simple interest, it'll save you a lot on repayments. But if you are depositing a money on simple interest, then you will not earn as much as compound interest can give you. Therefore, it is important check the type of interest offered on a financial product before opting for one.