A quick and easy method of calculating the interest charged on a loan is called Simple Interest. It is determined by multiplying the interest rate by the principal amount, by the number of periods(days/months/years) that have elapsed between the payments.
In layman’s term, simple interest definition can be explained as the rate at which you borrow or lend money. If a borrower takes money as a loan from a lender for a certain period, an extra amount of money is paid back to the creditor based on the rate of interest. This extra amount which is paid back to the creditor for availing the loan is called the interest component.
A simple interest calculator can be a digital tool that calculates the interest on loans without compounding. For calculating the same you must enter the principal amount, interest rate, and tenure. Digital calculator will display EMI (Equated Monthly Instalments) on the loan. You can use this calculator to measure interest on the principal amount on a daily, monthly, or yearly basis. This digital calculator can be found in many financial institutes or aggregator website.
The simple interest calculator is programmed to work on the mathematical simple interest formula also which looks like this:
Simple Interest = (P×I×N)/100
P=Principal amount borrowed
I=Interest rate (Yearly)
N=Number of periods that elapse between payments e.g., if it is a 6-month period and the total tenure is 1 year then there will be 2 periods.
Here is a simple interest formula example for better understanding of the formula: Let’s assume a student obtains a simple interest loan to pay one year of university tuition, which costs Rs. 50,000. And the annual interest rate for the loan is 7%. The student repays the loan in 5 years and each period is equal to 1 year. Then using the formula amount of simple interest paid is calculated as follows:
Rs. 17,500 = Rs. (50,000 x 7 x 5)/100
And the total amount to be paid by the student will be:
Rs. 67,500 = Rs. 50,000(Principal Amount) + Rs. 17,500 (Interest Amount)
This example will help you understand simple interest meaning more clearly.
Simple interest mostly applies to staff loans which is provided by organization to its staff. The interest is calculated on the principle. However, there is no interest that is calculated on the accrued interest.
It is also used for Education Loans in certain lenders. In pure business terms, simple interest is beneficial to the borrower and not for the lender. Hence, it is not a preferred repayment method for lenders.
Simple interest is often calculated daily, therefore it mostly benefits people who have a daily inflow in money to pay their loans on or before time.
Interest charged on a particular loan can be simple or compounded in nature. Repayment amount calculation for a Simple Interest is based on current principal amount whereas, for a Compound Interest calculation for EMI is based on the principal amount and the interest that accumulates on it in every cycle. This is the major difference between simple interest and compound interest.
Compound interest is used by all major lenders to calculate the repayment amount on an Online Personal Loan and Business Loan of a borrower.
Compound interest is defined as below:
Compound Interest = Total Amount – Principal
Here Total Amount (A) can be calculated using the formula given below:
P = Principal amount
r = rate of interest
n = number of times interest is compounded every year
t = time period
Example – Let’s assume a borrower takes a loan of Rs. 2000 for 1.5 years at 10%p.a. Now we need to calculate the compound interest paid for the loan half-yearly.
Then using the compound interest formula,
Principal, P = Rs.2000
Time, t= (3/2) years
Rate, r = 10%
Frequency, n=2 as the loan is paid half-yearly
Total Amount, A can be calculated as:
A = Rs. 2315.25
Compound Interest = A – P = Rs.2315.25 – Rs.2000 = Rs.315.25
Simple interest can be defined as the amount of interest charged on a principal amount at a given rate and for a given period.
Compound interest can be simply defined as the interest calculation based on the initial principal amount plus the interest accumulated to the principal balance at a given rate and for a given period.
S.I. = (P × T × R) ⁄ 100
Compound Interest = Amount – Principal
The repayment amount is much lesser compared to compound interest.
The repayment amount is higher compared to simple interest.
The interest component increases uniformly.
The interest component increases at a faster rate compared to compound interest
The interest rate is only charged on principal amount.
The interest rate is charged on the principal and accumulated interest.
Simple interest loans have many benefits. When we make a repayment for a simple interest loan, the payment will go towards interest and principal amount both. In a compound interest scenario, during repayment the interest component is paid first and only when it interests payment is done remaining amount goes towards payment of principal.
Below it has been described in detail:
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