SIMPLE AND COMPOUND INTEREST: Difference, Formula and Examples   

Simple and compound interest
Photo Credit: SmartAsset.com

We know that the borrower must pay the lender for the loan with interest. The interest can be either simple or compounded, and we commonly state it as a percentage. A loan or deposit’s principal amount serves as the basis for simple interest. Compound interest, on the other hand, is calculated based on both the initial principal and the interest that is added to it each period. This article will guide you on all you need to know about simple and compound interest, the differences between simple and compound interest, the simple and compound interest Calculator, Simple and compound interest formula with examples.  

Simple Interest

Simple interest is a simple and straightforward formula for figuring out how much interest will be charged on a loan. Divide the daily interest rate by the principle and the number of days between payments to get simple interest. We associate this type of interest with auto loans or short-term loans, though some mortgages use it. Most US mortgages with an amortization plan are simple interest loans, despite their appearance. On a simple-interest loan, we split your payment between principal and interest. Since we pay monthly, interest never accumulates. Take a look at an auto loan with a $15,000 principal balance and a 5% yearly simple interest rate to better understand how simple interest works. If you pay your bill on May 1, even though it’s due, the loan company will calculate your interest for April.

In this case, the interest you pay for 30 days is $61.64. The finance company will only charge interest for 20 days in April if you pay on April 21. This reduces your interest payment to $41.09, saving you $20.

Why Simple Interest Is Beneficial

Since interest is usually computed on a daily basis, simple interest typically rewards borrowers who pay their debts on time or early each month.

Simple Interest Formula With Examples

The calculation of simple interest is straightforward. This is what it appears to be:

Simple Interest = PIN where:

P=Principal

I stand for the daily interest rate.

N=Days between payments

Simple interest is often a predetermined percentage of the principal amount borrowed or lent that is paid or received over the course of a given period.

Say, for instance, that a student takes out a simple-interest loan with an annual interest rate of 6% to cover the $18,000 cost of a year’s worth of college tuition. Over the course of three years, the student repays the debt.

We pay simple interest at a rate of $3,240, which is equal to $18,000× 0.06× 3

$3,240=$18,000×0.06×3

Moreover, the total amount paid is:

A=P+I

$21,240=$18,000+$3,240

​Simple Interest Calculator

A handy tool known as a basic interest calculator can be used to compute interest on savings accounts or loans without compounding.

Daily, monthly, or annual calculations of the simple interest on the principal amount are all acceptable. In the formula box of the simple interest calculator, you can enter the principal amount, annual percentage rate, and time duration in days, months, or years.

Simple and Compound Calculator for Interest Work

The straightforward interest calculator will display the accrued amount, which includes both principal and interest. The basic interest calculator uses the following equation:

A = P (1+rt)

Principal Amount is P.

R is the interest rate.

t = The number of years.

A = Total amount accumulated (Both principal and the interest)

A-P = interest.

Let’s imagine we want to lend a friend $5,000 for a period of four years at a 5% annual interest rate. Your calculation might appear as follows:

Our equation is A = P(1 + rt).

P = 5000.

R = 5/100 = 0.05 (decimal).

T = 4.

When we enter those numbers into our basic interest formula, we obtain:

A = 5000 × (1 + (0.05 × 4)) = 6000.

I believe that the Simple and Compound Interest Calculator has helped shed some light on the subject for you.

Compound Interest

Compound interest, often known as interest on principal and interest, is the adding of interest to the loan or deposit principal.

It happens when interest is reinvested, added to the loaned capital, or required to be paid by the borrower rather than being paid outright. As a result, we earn interest on the principal amount plus any accumulated interest during the following period.

Compound interest (also known as compounding interest) is a term used to describe this type of interest. The frequency of compounding affects how quickly compound interest accumulates. The compound interest grows as the number of compounding periods increases.

For instance, $100 compounded at 10% annually will accrue less compound interest over the course of the same period than $100 compounded at 5% semi-annually.

Compound Interest Types

Periodic Compounding: With this procedure, the interest rate is generated and applied periodically. This interest increases the principal. Periods in this context refer to yearly, biennially, monthly, or weekly.

Continuous Compounding: This technique computes interest at the lowest possible intervals using a natural log-based formula. This interest increases the principal.

Why Compound Interest Is Beneficial

When it comes to savings and investments, compound interest is your best ally. You stand to gain far more from the interest that is payable if you invest in them.

However, when it comes to calculating the interest on your loan or other debt, compound interest will be your biggest enemy. The total amount of interest you pay for your loan will be much higher. Compounding interest is an excellent strategy to maximize your return on fixed deposits.

Compound interest in long-term investments increases returns significantly. Your interest might increase even more with compound interest that is paid on a monthly, quarterly, or semi-annual basis.

Listed Below Are Some Advantages of Compound Interest:

  • Reinvestment: The interest will be added back to the original deposit.
  • Higher deposit value – Deposit values rise as a result of compound interest. Your deposit will be more when it matures than just a simple interest deposit.
  • Compound interest accounts encourage saving for the long term because the return on investment is substantially higher after 10 years or more.
  • Increased Earnings – Compounding options that are available on a monthly, quarterly, and semi-annual basis boost interest earnings.

Compound interest is applicable to certain financial platforms. The financial industry uses it for both credit and debit transactions. Some credit and investment options that utilize compound interest are listed below.

  • Investments
  • Money Market Accounts
  • Fixing Deposits
  • Deposits that Recur
  • Various Certificates of Deposit
  • Invested Dividend Stocks
  •  Retirement Funds
  • Debt
  • Finance
  • Mortgages
  • Credit Cards

We stand to gain from its use when it comes to savings and investments. Compound interest, on the other hand, benefits banks and lenders because it increases the value of loans and debt.

Compound Interest Formula With Examples

We calculate compound interest using the formula A = P (1 + r/n) ^nt, where P represents the principle balance, r is the interest rate, n is the number of times interest is compounded each time period, and t is the total number of time periods.

Example 1

The investment’s worth after 10 years may be determined using the following formula if $5,000 is deposited into a savings account with a 5% annual interest rate that is compounded monthly.

P = 5000. r = 5/100 = 0.05 (decimal).

n = 12. t = 10.

When we enter those numbers into the formula, the results are as follows: 

A = 5000 (1 + 0.05 / 12) (12 * 10) = 8235.05.

Consequently, the investment balance at the end of ten years is $8,235.05.

Example 2

If $5,000 is deposited into a savings account with a monthly interest rate of $100 and an annual interest rate of 5% compounded annually (made at the end of each month). The following formula can be used to determine the investment’s worth after ten years.

 P = 5000. PMT = 100. r = 5/100 = 0.05 (decimal). n = 12. t = 10.

When we enter the numbers into the formulas, we obtain:

Total is made up of [compound interest on the principal] and [future value of a series].

Total is [P (1+r/n) (nt)] + [PMT (1 + r/n) (nt) – 1) / (r/n)] [5000 (1 + 0.05 / 12) ^ (12 × 10)] + [100 × (((1 + 0.00416)^(12 × 10) – 1) / (0.00416))] [5000 (1.00416) ^ (120)] + [100 × (((1.00416^120) – 1) / 0.00416)] [8235.05] + [100 × (0.647009497690848 / 0.00416)] [8235.05] + [15528.23] [$23,763.28]

Thus, the investment’s remaining balance after ten years is $23,763.28.

I hope the preceding illustrations of the compound interest formula were helpful.

Differences Between Simple and Compound Interest

Simple interest is simpler to compute than compound interest because it is just applied to the principal of a loan or deposit.

Regardless of how long the loan term is, simple interest is interest calculated solely on the loan’s principle.

The interest calculated on the principal amount, plus any interest that has accrued over time, is known as compound interest.

Because you may earn interest on interest, compounding interest is frequently the best option when saving money. But if you need a loan, a simple interest loan might be a better choice because it might result in lower overall expenditures.

Conclusion

By making consistent investments and increasing the frequency of your loan repayments, you
may put the power of compounding to work for you. Understanding the fundamentals of a simple and compound interest calculator or formula will enable you to make wiser financial decisions, which will ultimately result in thousands of dollars in savings and an increase in your net worth.

Simple And Compound Interest FAQs

Which type of income—compound interest or basic interest—helps my investments grow more quickly?

Using the compound interest method to calculate your investments will result in faster growth than using the simple interest approach because compound interest is calculated annually on both the principal and interest amounts, whereas simple interest is calculated solely on the primary amount.

What schedule does the bank used to calculate the interest that is compounded?

Banking savings accounts use a daily schedule for compounding interest.

What is Simple and Compound Interest Calculator?

The basic simple and compound interest calculator uses the following equation:

  • A = P (1+rt)
  • Principal Amount is P.
  • R is the interest rate.
  • t = The number of years.
  • A = Total amount accumulated (Both principal and the interest)
  • A-P = interest.
  1. RULE OF 72:Meaning and Formula
  2. Present Value Formula: Definitions, Examples, Formula & Calculations
  3. THE ANNUAL PERCENTAGE YIELD: How It Works With Your Savings Account
  4. DATA STRATEGY: 7 Component of Data Strategy every Compound needs
0 Shares:
Leave a Reply

Your email address will not be published.

You May Also Like