How to Calculate Interest?

Understanding interest is vital in finance. Jagadeesh, a software engineer from Mumbai, shows how disciplined loan repayment can lead to financial stability and success.

He is not a finance expert, but just a random guy who had taken a loan of ₹ 3,00,000, with 12 % interest rates for 3 years. Thus, the EMI comes to ₹ 9,964. Let’s examine his monthly expenses:

• Loan ₹ 3,00,000
• Interest Rate: 12 %
• Tenure: 3 Years
• Monthly Salary: ₹ 40,000
• Monthly EMIs: ₹ 9,964
• Rent: ₹ 8,000
• Groceries: ₹ 7,000
• Fuel Expenses: ₹ 4,000
• Remaining Cash: ₹ 11,036

Even though 25% of Jagadeesh’s salary went into EMIs, he repaid his ₹3,00,000 loan with ₹3,58,704 total repayment. His consistency paid off. Like him, you too can manage multiple loans smartly. This blog helps you understand how to calculate interest easily.

Interest – A Short Overview

For Example, Kumaari wanted to buy a fridge for ₹40,000 but couldn’t pay upfront, so she took a one-year loan at 12% interest. She repaid ₹44,800, paying ₹4,800 extra as interest. Meanwhile, her friend Kaushik deposited ₹2,00,000 in a savings account earning 3.5% interest, which grew to ₹2,07,000 in a year, a ₹7,000 gain. 

In a light-hearted chat, Kumaari joked that while she paid interest, Kaushik earned it like a salary. Kaushik explained that interest works both ways; you either pay for borrowing money or earn by saving it. It’s all about using someone else’s money, smartly or wisely.

Components in Calculating the Interest

Let’s see understand this through the story of Vimala, a budding entrepreneur from Gujarat, who planned to open a boutique shop. So she approached the bank for a loan. After examination of her credentials, the bank approved a loan amount of ₹ 6,00,000, which was the Principal (P). 

This was the actual money that she borrowed for her business. The bank charged her an interest rate of 12% per annum (R), with a tenure of 5 years or 60 months (T). 

All three components were essential to calculate her interest:

• Principal: ₹ 6,00,000 (P)
• Rate of Interest: 12 % per annum (R)
• Time: 5 years (T)

Here, Vimala would have paid ₹ 3,60,000 as the interest for five years, while the total loan amount is ₹ 9,60,000 (₹ 6,00,000 + ₹ 3,60,000).

Two Types of Interest Calculations

The interest calculation revolves around the two methods of calculation, namely simple interest and compound interest. Both of these calculations are used in different contexts, following the type of financial business.

Simple Interest Calculation

This is the basic method for the calculation of interest. The calculations are done only on the initial principal amount. The accrued interests are not added to the initial principal amount, thus making the interest the same over the entire duration of time.

The formula to calculate the simple interest is:

Interest (I) = Principal (P) * Rate (R) * Time (T)/100

Consider this example for this calculation, where P = ₹ 10,000,000 ; R = 5% ; Time = 3

             = 10,000,000*5*3/100

             = 1,500,000

Therefore, the interest accrued for the ₹ 10,000,000 is ₹ 1,500,000 for 3 years at 5%.

To find the overall amount, you need to follow the following formula:
 

Total Amount = Principal + Interest

             = 10,000,000+1,500,000

             = 11,500,000

Therefore, the total amount after the 3 years is ₹ 11,500,000.

Compound Interest Calculation

This is the usual method which is being used in all the financial institutions. Here, there is a calculation on the accumulation of interest from the previous period. Hence, the interest gets accrued on an interest. The compound interest method is often used for long-term loans.

The formula to calculate the total amount with compound interest is:

A = P (1 + R / 100*n) nt

Here, nt refers number of times for which the interest is compounded per year. This is usually calculated as follows:

Consider this example for this calculation, where P = ₹ 10,000,000; R = 5%; Time = 3 and n – 1

             = 10,000,000 (1 + 5 / 100*1)1*3

             = 10,000,000 (1.05)1*3

             = 10,000,000*1.157625

             = ₹ 11,576,250

After this calculation, the compound interest is calculated based on the following formula:

CI = A – P

So, this is how the math goes:

CI = 11,576,250 - 10,000,000

= ₹ 15,76,250

Differences between Simple Interest and Compound Interest

Loan Calculator

In the era of digital transformation, the calculation of interest is simpler as well as easier. This is because many online websites introduce a loan calculator on their platform. Only the required details of principal amount, years, and time duration need to be entered to fetch the results.

Key Features of Loan Calculator

Vasudev is a software engineer from Noida, who plans to renovate his home before this Diwali. So he decides to take a loan. He navigates to the loan market of different banks and ends up in confusion. His friend Dhivakar suggests using an online loan calculator, which is the ultimate key for many loan applicants, like him.

Surprised to know such an existence on the internet, he hit the website of a free online loan calculator and entered the following details: 

• Principal: ₹ 8,00,000 (P)
• Rate of Interest: 13.5 % per annum (R)
• Time: 5 years (T)

In a fraction of a second, the online loan calculator displayed the following results:

• Monthly EMI: ₹ 18,408
• Total Interest: ₹ 3,04,473
• Overall Amount: ₹ 11,04,473

Vasudev was amazed by the quick loan calculator results. It saved time and helped him plan his home renovation budget easily. Had he calculated manually, it would've taken 15 minutes and delayed the entire budgeting and renovation process.

Conclusion

Today, the calculation of interest is not rocket science. Anyone can calculate the interest in their comfort zone by using these methods. Indeed, the online loan calculator has become a life-saving tool, which gives precise results on the interest calculations. The loan applicant has to ensure, the type of calculation that the bank adopts in its policy.

FAQs

1. What is the formula to calculate the simple interest?

The formula to calculate the simple interest is Interest (I) = Principal (P) * Rate (R) * Time (T)/100.

2. What is the formula to calculate compound interest?

The formula to calculate the simple interest is A = P (1 + R / 100*n) nt.

3. On which type of calculation, the interest get accrued on interests?

It is done on compound interest.

4. Is the online loan calculator safe to use?

The online loan calculator is safe to use.

5. What does the word “P” stand for in these calculations?

  It is the principal amount, which is the initial sum of money.

Apply for Loans Fast and Hassle-Free

Apply Now

About the Author

LoansJagat Team

We are a team of writers, editors, and proofreaders with 15+ years of experience in the finance field. We are your personal finance gurus! But, we will explain everything in simplified language. Our aim is to make personal and business finance easier for you. While we help you upgrade your financial knowledge, why don't you read some of our blogs?