What Is Simple Interest? Formula, Calculation & Examples

Simple interest is the extra money paid, charged when borrowing or lending money. It is calculated on the original amount for some period of time.

Example:

Nitin friend give him ₹10,000 at 5% interest rate per annum at the interest rate of 3 years. He is charged interest only on the original amount of ₹10,000, not on any additional interest. When the 3-year period has completed, Nitin gives back the money with interest.

Calculation:
 

Simple Interest Formula:

• I=P×R×T
• I=10,000×0.05×3=₹1,500

Simple interest can be easily calculated and is fair when dealing with short-term borrowing.

This blog help you to understand simple interest, how to calculate and financial use of simple interest.

How to Calculate Simple Interest?

Simple interest is the additional money that is added to a loan or borrowed money. It is calculated only on the original amount(principal) for the fixed period.

Example:
 

Nitin takes a bank loan of ₹20,000 at 6% per annum interest rate for 4 years. He is only paying interest on the principal amount (₹20,000) and no accumulated interest. Nitin pays back the loan, together with the interest, in 4 years.

Calculation of Simple Interest:
 

Steps to Calculate Simple Interest:
 

1. Identify Principal (P): The original amount borrowed or invested (₹20,000).
    
2. Check Interest Rate (R): The percentage charged per year (6%).
    
3. Determine Time (T): The loan period in years (4 years).
    
4. Use the Formula:

Simple Interest (I)=P×R×T

I=20,000×0.06×4=₹4,800
 

5. Total Repayment = Principal + Interest = ₹20,000 + ₹4,800 = ₹24,800.

Simple interest is simple and useful in case of a small duration of a loan, and there is no such hard calculation of how much additional payment you will pay or how much you will earn.

Simple Interest vs Compound Interest

The interest could be compound or simple, with the extra money paid or earned on the loans or investments. The principal difference is that simple interest is added only on the principal amount, whereas compound interest is added on the original amount plus any accumulated interest( to increase over the period).

Example:
 

• Simple Interest: Nitin invests ₹10,000 at 5% per year for 3 years. He only makes ₹10,000 interest each year.
• Compound Interest: If the same ₹10,000 is compounded annually at 5% then he gains the interest on the increasing amount every year.

Comparison Table:

This table compares how simple interest and compound interest grow on an initial investment of ₹10,000 over three years.
 

Compound interest yields higher returns by earning interest on accumulated interest, making it more powerful for long-term savings.

Compound interest helps in growing money faster as compared to simple interest, which is simple to figure out. Simple interest is also used in short-term loans.

Financial Uses of Simple Interest

Simple interest is applied in the calculation of interest only on the principal that has been borrowed and invested. This is common in short-term loans and certain forms of investments.

Example:

Nitin takes a car loan of ₹3,00,000 at 8 % simple interest over 5 years. He will only pay interest on the original amount of ₹3,00,000, not on any additional interest. He pays back the loan after 5 years with interest.

Simple Interest Calculation:

This table shows the interest and total repayment for a ₹3,00,000 loan at 8% annual interest over 5 years.

The borrower will repay ₹4,20,000 in total, with interest accounting for ₹1,20,000 of the amount paid.

Where Simple Interest is Used

Simple interest is commonly used for short-term loans and some fixed-income investments, making calculations straightforward.
 

• Short-Term Loans: Personal loans, car loans (like Nitin’s), or small business loans.
   
• Fixed Deposits: Some banks offer simple interest on short-term FDs (1-2 years).
   
• Government Schemes: Some savings bonds or post office schemes use simple interest.
   
• Education Loans: Some student loans only calculate interest for repayment.
   

It's ideal for borrowers and investors seeking predictable, linear growth without compounding complexity.

Simple interest makes loans and investments more straightforward so that people such as Nitin can easily plan their finances.

Conclusion

One of the simplest methods to calculate interest is the simple interest, which is useful for everyday borrowing and lending. Consider the case of Nitin, who is buying a house and obtains a 2-year loan of ₹50,000 at 6% simple interest. He is clear on how much extra he is going to pay, only ₹6,000 (₹50,000 x 6% x 2). 

The simple interest does not compound like compound interest, which calculates the interest on both the principal and interest earned. This becomes predictive in lines of short-term loans such as personal loans, car loans, or small investments. 

The common thing in simple interest is that it does not multiply money as compound interest does, but it makes repayment planning easier so that people like Nitin do not lose sleep. By understanding how simple interest works, one will make better decisions either when taking a loan or when investing in a fixed deposit. 

FAQs 

Can simple interest apply to savings accounts?

No, savings accounts usually use compound interest. Simple interest is rare here because it gives lower returns over time.

What’s the formula for simple interest?

Interest = (Principal × Rate × Time) / 100. Example: ₹20,000 at 3% for 4 years = (20,000 × 3 × 4)/100 = ₹2,400.

Does simple interest change over time?

No, it stays the same every year because it’s always calculated on the original amount, not the growing balance.

When should I choose a simple interest loan?

Pick it for short-term needs (1–5 years) when you want predictable, lower interest payments. Avoid it for long-term loans.

How do I know if my loan uses simple or compound interest?

Check your loan agreement; banks usually mention it. Most personal/car loans use simple interest unless specified otherwise.

Can I negotiate the interest rate on a simple interest loan?

Yes, some lenders may reduce the rate if you have good credit or bargaining power. Always ask before signing!

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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?