What is Simple Interest?
Interest is the cost you pay to borrow money or the compensation you receive for lending money. You might pay interest on an auto loan or credit card, or receive interest on cash deposits in interest-bearing accounts like savings accounts or certificates of deposit (CDs).
Simple interest is interest that is only calculated on the initial sum (the "principal") borrowed or deposited. Generally, simple interest is set as a fixed percentage for the duration of a loan. No matter how often simple interest is calculated, it only applies to this original principal amount; in other words, future interest payments won't be affected by previously accrued interest.
The Simple Interest Formula
The basic simple interest formula looks like this:
Simple Interest = Principal Amount × Interest Rate × Time
Our calculator will compute any of these variables given the other inputs.
Simple Interest Calculated Using Years
You may also see the simple interest formula written as:
I = Prt
- I = Total simple interest
- P = Principal amount or the original balance
- r = Annual interest rate
- t = Loan term in years
Under this formula, you can manipulate "t" to calculate interest according to the actual period. For instance, if you wanted to calculate interest over six months, your "t" value would equal 0.5.
Simple Interest for Different Frequencies
You may also see the simple interest formula written as:
I = Prn
- I = Total interest
- P = Principal amount
- r = Interest rate per period
- n = Number of periods
Under this formula, you can calculate simple interest taken over different frequencies, like daily or monthly. For instance, if you wanted to calculate monthly interest taken on a monthly basis, then you would input the monthly interest rate as "r" and multiply by the "n" number of periods.
Simple Interest vs Compound Interest
Compound interest is another method of assessing interest. Unlike simple interest, compound interest accrues interest on both an initial sum as well as any interest that accumulates and adds onto the loan. (In other words, on a compounding schedule, you pay interest not just on the original balance, but on interest, too).
Over the long run, compound interest can cost you more as a borrower (or earn you more as an investor). Most credit cards and loans use compound interest. Savings accounts also offer compounding interest schedules.
Which is Better for You: Simple or Compound Interest?
As a borrower, paying simple interest works in your favor, as you'll pay less over time. Conversely, earning compound interest means you'll net larger returns over time, be it on a loan, investment, or your regular savings account.
For a quick example, consider a $10,000 loan at 5% interest repaid over five years. On a simple interest basis, this loan totals $12,500. If compounded monthly, you'd repay a total of $12,833.59. Over time, the difference builds up exponentially.
Frequently Asked Questions
Simple interest is calculated solely on the original principal amount. Compound interest is calculated on both the principal amount and the accumulated interest from previous periods. Compound interest grows much faster over long periods.
To calculate simple interest for months, divide your annual interest rate by 12 to get the monthly rate. Then, multiply that monthly rate by the number of months and the original principal amount. Alternatively, convert the months into a fraction of a year (e.g., 6 months = 0.5 years) and use the standard annual formula.
Simple interest is commonly used for short-term personal loans, auto loans, and some types of mortgages where interest doesn't compound daily. It is also used in certain bonds that pay a fixed interest coupon.
Yes, if you are making regular payments toward an amortized loan, the principal balance decreases over time. In a simple interest amortized loan, your interest payment each period is based on the remaining principal, not the original starting amount.
When solving for the 'Term' using exact end balance, principal, and rate figures, the math often yields a fractional value. A decimal term like 5.5 years simply means 5 years and 6 months.