Simple interest and Compound Interest concepts
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1. What is Simple Interest?
The cost of borrowing is expressed as simple interest (SI). It is basically interest on the principal amount expressed as a percentage of the principal amount. Borrowers will gain from simple interest since they will only have to pay interest on loans they take out. In other terms, simple interest is the amount paid to the borrower for using borrowed funds for a set period of time.
It is simple to compute, Simple interest is calculated by multiplying the interest amount by the tenure and principal amount. Simple interest disregards previous interest. It is based solely on the initial contribution amount.
When calculating interest payments on auto and consumer loans, basic interest is used. Even a certificate of deposit calculates the return on investment using simple interest.
2. What is Compound Interest?
Compound interest (CI) earns interest on previously earned interest, as opposed to simple interest, which earns interest just on the principal sum. The interest is applied to the principal. CI stands for Interest on Interest. The entire concept relies on producing significant returns by compounding interest on the main sum.
In other words, CI has the potential to earn a higher return than simply earning interest on an investment. Because compound interest is based on the principal power of compounding, investments rise exponentially.
The frequency of compounding is determined by the bank financial institution or lender. It can be done on a daily, monthly, quarterly, half-yearly, or annual basis. The higher the frequency of compounding, the greater the amount of interest accrued. As a result, investors benefit more from compound interest than debtors.
3. What is the formula for Simple interest and Compound Interest formula?
| Formulas for Interests (Simple and Compound) | |
| SI Formula | S.I. = Principal × Rate × Time |
| CI Formula | C.I. = Principal (1 + Rate)Time − Principal |
4. Difference Between Simple Interest and Compound Interest?
Simple interest interest and Compound interest both are different you can see the below table.
| Simple interest | Compound Interest |
| S.I= P*R*T/100 | C.I= P(1+R/100)t – P |
| The return of the amount could be lesser | The return of the amount could be higher as compared with simple interest |
| The principle amount is constant in simple interest calculation | The principal amount may vary during the entire borrowing. |
| The interest will be charged on the principal amount | The interest will be charged on the principal amount and accumulated interest |
5. Examples of SI and CI
- A loan of Rs 4000 is taken out at a rate of 7%. For two years, what is the basic and compound interest rate?
Ans.
Simple Interest = Principle × Rate × Time = PTR/100
here Principle = 4000, Rate of interest = 7% and Time= 2 years
=Simple Interest = 4000 × (7 ⁄ 100) × 2
= Simple Interest = 560
Compound Interest = Principal × (1 + Rate)Time − Principal
Here principal= 4000, Rate= 7%, and Time = 2 years
So, Compound Interest = 4000 × (1 + 7 ⁄ 100)2 − 4000
= Compound Interest = (4000 × 1.1449) − 4000
= Compound Interest = 580
The compound interest is Rs. 580 and Simple interest is Rs 560
- A loan with a principal amount of INR 50,000 and a 60-day term and interest rate of 5% annually is being offered. Calculate the Simple Interest.
Ans. Given,
Principal amount 50,000, time 60 days and rate of interest = 5% or 0.014% per day.
S.I= Principle × Rate × Time = PTR/100
Hence, Simple interest = INR 410.95
- After four years, a fund of Rs. 25,000 becomes Rs. 30,000 when simple interest is applied. Determine the interest rate.
Ans. Given,
Principal = Rs. 25000
Time = 4 years
Amount at the end of 4 years = Rs. 30000
so, Simple interest = Principal – Amount at the end of 4 years
SI = Rs. 30000 – Rs. 25000 = Rs. 5000
SI = P× T× R / 100
R = SI × 100 / PT
R = 5000 × 100 /( 25000 × 4)
R = 5%
Hence, the rate of interest = 5%
6. FAQ's
1. What is the relationship between SI and CI?
Ans. While both types of interest will increase your money over time, there are significant differences between them. Simple interest is paid solely on the principal, whereas compound interest is paid on the principal plus all past interest gained.
2. Will SI and CI be equal?
Ans. Compound interest is equal to S.I. for one year but always greater than S.I. for more than one year.
3. What is the difference between CI and SI?
Ans. Simple interest is computed on the principal amount only, whereas compound interest is calculated on the principal amount plus the interest accumulated at the end of each year. I
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