Simple interest and compound interest

Interest is the cost of borrowing money, where the borrower pays a fee to the lender for the loan. Interest, usually expressed as a percentage, can be simple or compound. Simple interest is based on the principal amount of a loan or deposit. In contrast, compound interest is based on the principal amount and the interest that accrues on it each period. Simple interest is calculated only on the principal amount of a loan or deposit, so it is easier to determine than compound interest. Today in this blog we want to tell you information about compound interest and simple interest , so that you can know what the meaning of these concepts is. So keep enjoying this blog and learn a little more about interest.

Simple interestCompound interest
Definition Simple interest can be defined as the amount repaid for using the borrowed money, over a fixed period of time.Compound interest can be defined as when the principal amount exceeds the due date for payment along with the interest rate, over a period of time.
FormulaS.I. = (P × T × R) ⁄ 100C.I. = P(1+R⁄100)t − P
Return amount
 
The return is much lower compared to compound interest.The return is much higher.
Main quantityThe principal amount is constant.The principal amount continues to vary throughout the loan period.
IncreaseGrowth remains fairly uniform in this method.Growth increases quite quickly with this method.
Interest chargedThe interest charged is for the principal amount.The interest charged is for the principal and accrued interest.

What is interest?

Interest is the cost of using someone else’s money. When you borrow money, you pay interest. When you loan money, it earns interest. Interest is calculated as a percentage of the balance on a loan (or deposit), which is paid to the lender periodically for the privilege of using your money. The amount is generally quoted as an annual rate, but interest can be calculated for periods that are longer or shorter than a year. Interest is additional money that must be repaid in addition to the original loan balance or deposit.

How does interest work?

There are several different ways to calculate interest, and some methods are more beneficial to lenders. The decision to pay interest depends on what you get in return, and the decision to earn interest depends on the alternative options available to invest your money.

When you borrow, you must repay what you borrowed. Also, to compensate the person who lent the money for the risk of lending to you (and their inability to use the money elsewhere while using it), they must pay back more than they borrowed.

When you lend money because if you have extra money available, you can either lend it yourself or deposit the funds in a savings account, allowing the bank to lend or invest the funds. In return, you will expect to earn interest. If you are not going to win anything, you may be tempted to spend the money instead, because waiting has few benefits.

How do I earn interest?

You earn interest when you loan money or deposit funds into an interest-bearing bank account, such as a savings account or certificate of deposit. Banks make the loans for you because they use your money to offer loans to other customers and make other investments, and they transfer a part of that income to you in the form of interest.

Periodically the bank pays interest on your savings. You will see a transaction for the payment of interest and you will notice that your account balance increases. You can either spend that money or keep it in the account so that it continues to earn interest. Your savings can really build momentum when you leave interest on your account. You will earn interest on your original deposit, as well as interest added to your account. Earning interest in addition to the interest you previously earned is known as compound interest.

What is simple interest?

Simple interest is a percentage of the principal added to that principal regularly. Interest (i) is the sum of the principal (p) multiplied by the interest rate (r). This gives you the amount of interest that will be added to the principal in each accumulation period, for example, each year.

Simple interest is calculated using the following formula:

Simple interest = P × r × n

where:

P = Main import

r = annual interest rate

n = Loan term, in years

Generally, the simple interest paid or received during a given period is a fixed percentage of the principal amount that was borrowed. For example, suppose a student takes out a simple interest loan to pay for one year of college tuition, which costs $ 18,000, and the annual interest rate on the loan is 6%. The student repays the loan in three years. The amount of simple interest paid is:

$ 3,240 = $ 18,000 × 0.06 × 3

and the total amount paid is:

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

What is the composed interest?

Compound interest is a percentage of the principal amount that includes all previously earned interest. In other words, in each interest accrual period, the amount of interest added to the principal is calculated based on the principal plus the interest added in the previous period. Compound interest accrues and is added to the accrued interest from previous periods; it includes interest upon interest, in other words. The compound interest formula is:

Compound interest = P × (1 + r) t −P

where:

P = Main import

r = annual interest rate

t = Number of years the interest is applied

It is calculated by multiplying the principal amount by one plus the annual interest rate increased by the number of compounding periods, and then less the principal reduction for that year. With compound interest, borrowers must pay interest on both the interest and the principal.

Differences between simple and compound interest

There are some significant differences between simple and compound interest:

  • The main difference between simple interest and compound interest is that simple interest is based on the principal amount, while compound interest is based on the principal amount and compound interest for a cycle of the period.
  • Simple interest is easier to calculate.
  • Simple interest is always the same amount since it is a percentage of the principal. The amount of compound interest will be different in each accrual period, since it is a percentage of the principal plus the interest accrued or accrued to date.
  • The principal remains the same with simple interest. With compound interest, compound interest is added to the principal, increasing the principal amount.
  • Since the interest charge and principal amount are the same in all accrual periods with a simple interest loan, you will not be charged the outstanding interest when you pay off the loan.
  • Simple interest is best for purchases like auto loans, since the cost of the loan is static. Compound interest is better for investing or saving, as your funds will grow faster.

I hope you liked all the information that we give you in this blog …

Add a Comment

Your email address will not be published. Required fields are marked *