The rate at which you borrow or give money is called simple interest. The borrower pays back an additional amount of money to the lender on taking money from the lender. The borrowed funds which is taken from the lender for a specific period is called the principal. The additional amount paid back to the lender is called the interest. 

The simple interest is computed as a product of the principal amount and the number of periods and the interest rate. It is not interest on interest and does not get compounded. In this concept, the payment is with respect to the interest for the month, and paying will decrease the principal amount. 

Formula for Simple Interest 

The formula for computing the simple interest is, (P x r x t) ÷ 100

Here P is the Principal

R is the rate of interest

T is the tenure of the loan or deposit in years

This means that you are multiplying the principal amount by the rate of interest and the duration of the loan or deposit. The tenure should be in years and not in months. If you are giving the input for the time period in months, then the formula will be 

(P x r x t) ÷ (100 x 12)

The formula for the maturity value of the deposit or the total amount to be paid including the principal and interest is: 

FV = P x (1 + (r x t))

Here, FV is the future value

Interest payable or receivable is FV - Principal amount 

Let us now see how much you will have to pay on your loan if your bank uses simple interest.  

Computation of Simple Interest in Deposits

Example 1: If you deposit Rs. 60,000 in a fixed deposit account for a tenure of 2 years at an interest of 8%, then the simple interest accrued will be:

(60,000 x 8 x 2) ÷ 100 = Rs.9,600

The interest you will get at the end of the 2-year tenure will be Rs. 9,600. Therefore, the maturity amount in the FD will be Rs. 69,600. 

Simple Interest Calculation in Loans

Say you have borrowed Rs. 4 lakhs as personal loan from a lender on simple interest. The interest rate is 20% and the tenure is 3 years. The interest that you will have to pay to the bank is  

(4,00,000 x 20 x 3) / 100 = 2,40,000

The interest you will be paying over a duration of 3 years will be Rs. 2.4 lakhs. Therefore, the total amount to be repaid to the bank will be Rs. 6.4 lakhs. On a monthly basis, this will come up to around Rs. 17,777. 

Differences Between Simple Interest and Compound Interest

Simple Interest 

Compound Interest

The simple interest is computed on the entire principal amount for the full tenure 

It is computed on the principal amount monthly, quarterly, half-yearly, or annually

The accumulated interest on the principal is not added to the computation of interest for the next period

The accumulated interest will be added to the calculation of interest for the next period

The accumulation of interest is slow

The accumulation of interest is quick since interest is accrued on the growing interest amount also 

Simple interest is not enough for savings and investments but is advantageous if you take a loan. 

Compound interest will earn you more on savings and investments but is costly on a loan. 

The borrower benefits from simple interest as he will be paying less on a loan that is taken on simple interest. The lender does not benefit.

It is advantageous to the lender but not to the borrower. The borrower will be paying more on a loan that is taken on compound interest.

It is easy to compute 

It is tough to compute

 

Simple Interest Calculator

  • It is a tool that computes the interest on loans without compounding
  • It computes the simple interest on the principal daily, monthly, or yearly.
  • Enter the principal, amount, annual rate, and period for computation in days, months, or years. Then, the calculator will show the interest instantly.

How Do Simple Interest Calculators Function?

The simple interest calculator will display the accumulated amount that includes both principal and interest. The calculator operates based on the formula:

A = P(1 + rt)

P is the principal amount 

R is the rate of interest

t is the number of years

A = Total accrued amount (Both principal and interest)

Interest = A - P. 

Let us now see an example: 

The principal amount is Rs. 20,000, the rate of interest is 20% and the number of years is six. The simple interest will be computed as

A = 20,000 (1 + 0.2*6) = Rs. 24,000

Interest = 24,000 - 20,000 = Rs. ,0004

Conclusion

A loan obtained with simple interest can help you save a lot on repayments. But, you will not earn as much as you do in loans given with compound interest. Therefore, it is ideal to check what interest is offered on a financial product before choosing one. 

FAQs on Simple Interest Formula

1. How do I calculate interest? 

The formula for computing the simple interest is P*R*T, where P is the principal amount (at the starting), R is the interest rate annually in the form of a decimal, and T is the number of time periods. (Generally one-year time periods). 

2. Does the formula for computing the maturity amount vary when the tenure is entered in months rather than years? 

Yes, if the tenure of your deposit is entered in months, a different formula is used for computing simple interest.