Simple Interest Calculator
Simple Interest Calculator: How It Works and How to Calculate
Understanding interest is essential whether you are borrowing money or investing. Interest is the cost of borrowing funds or the return earned on lending money. Examples include:
Paying interest on credit cards or auto loans
Earning interest on savings accounts or certificates of deposit (CDs)
Simple interest is one of the most straightforward methods of calculating interest. It is calculated only on the initial principal amount, unlike compound interest, which accrues on both principal and previously earned interest.
What is Simple Interest?
Simple interest is a fixed percentage of the principal amount borrowed or deposited over a specific time period. Unlike compound interest, simple interest does not include interest on interest, making it easier to calculate and predict.
Simple Interest Formula
The standard formula for simple interest is:
Simple Interest (I)=Principal (P)×Interest Rate (r)×Time (t)\text{Simple Interest (I)} = \text{Principal (P)} \times \text{Interest Rate (r)} \times \text{Time (t)}
Where:
I = Total simple interest
P = Principal amount (initial balance)
r = Annual interest rate (decimal form)
t = Time period in years
Example:
If you borrow $10,000 at 5% simple interest for 5 years:
Calculate interest per year: $10,000 Ă— 0.05 = $500
Multiply by the number of years: $500 Ă— 5 = $2,500
Total repayment: $10,000 + $2,500 = $12,500
Calculating Simple Interest for Different Periods
You can also adjust simple interest for different time periods or payment frequencies:
I=PĂ—rĂ—nI = P \times r \times n
Where:
n = Number of periods (monthly, daily, etc.)
r = Interest rate per period
Example:
A $10,000 loan with a monthly interest rate of 5% over 12 months:
10,000Ă—0.05Ă—12=6,00010,000 \times 0.05 \times 12 = 6,000
Total repayment = $10,000 + $6,000 = $16,000
Financial Instruments Using Simple Interest
Simple interest is common in:
Short-term loans
Bonds with interest coupons
Certain dividend-paying investments
Advantages:
Borrowers benefit because interest is only on the principal
Easier to calculate and predict payments
Disadvantages:
Investors may earn less compared to compound interest
Does not account for reinvested earnings unless manually reinvested
Simple Interest vs Compound Interest
Compound interest grows faster because interest is calculated on both the principal and accumulated interest.
Compound Interest Formula:
A=PĂ—(1+rn)nĂ—tA = P \times (1 + \frac{r}{n})^{n \times t}
Where:
A = Ending balance
P = Principal
r = Annual interest rate
n = Number of compounding periods per year
t = Time in years
Example:
A $10,000 loan at 5% compounded monthly over 5 years:
Total repayment = $12,833.59
Compared to simple interest: $12,500
Difference = $333.59 more with compound interest
Key Takeaway:
Borrowers save with simple interest loans
Investors earn more with compound interest accounts
Why Use a Simple Interest Calculator?
Using a simple interest calculator helps:
Estimate total interest on loans
Determine monthly, daily, or yearly payments
Compare simple vs compound interest options
Make smarter financial decisions for borrowing or investing