Simple Interest Rates vs Compound Interest Rates: Grow Your Money Smartly

Apr 17th 2024
Finance

Most of you might have learnt simple interest during your school days. Though most of us don’t pay careful attention to this mathematical thing, it is a very important part of our lives, particularly for those who indulge in investments of any type. Whenever we invest an amount in any financial tool, we expect it to grow and this is where interest rate matters. The higher the interest rate, the better growth our investment accrues. So, if you are looking to invest or already investing in a security, you must understand simple interest and simple interest calculator.

What is Interest Rate?

The interest rate is a crucial factor in determining the total amount of interest paid or earned on a loan or investment. It is calculated as a percentage of the principal sum and can vary based on factors such as:

• Compounding frequency
• Investment/Loan duration

Understanding how the interest rate affects the overall cost or return is essential for making informed financial decisions.

The annual interest rate is a percentage that represents the cost of borrowing money for one year. While there are different rates for shorter periods like a month or a day, they are typically calculated on an annual basis. Essentially, borrowers are willing to pay interest fees in exchange for accessing funds earlier than they currently have.

Types of Interest Rate

There are primarily two types of interest rates – simple and compound. If you are investing money somewhere, the set interest rate would define the maturity amount you would get from another person. If you invest money in a tool that gives returns based on simple interest, you can use the simple interest calculator and determine the maturity amount. In this post, you will get to know everything about simple interest and simple interest calculators.

What is Simple Interest?

Simple interest can be defined as a type of interest in which the same rate of interest becomes applicable over and again on the main principal amount. Any bank or financial institution where the money is deposited is obliged to pay interest on that amount. The interest applied by the banks can be of several types and one of them is simple interest.

A loan refers to a sum of money borrowed by a person from a bank or other financial institution to meet their requirements. Home loans, vehicle loans, education loans, and personal loans are a few examples. The borrower is expected to pay back a loan amount to the bank or financial institution after adding the interest rate.

Simple Interest Formula

What Is The Formula For Simple Interest? The calculation of simple interest is done using the formula.

S.I. = (P × R × T)/100, whereas P = Principal, R = Rate of Interest in % per annum, and T = Time

The rate of interest is defined in percentage % which can be noted as R/100, therefore 100 in the formula.

• Principal: The principal refers to an amount that is initially invested or borrowed from a bank. P stands for the principal.
• Rate: Rate is the interest rate at which the principal sum is given to a person for a specific tenure. The rate of interest is usually 7%, 10%, and 15%. R stands for the interest rate.
• Time: The amount of time that the principal is bestowed on an individual. T denotes time.

How Simple Interest Formula is Used?

The simple interest formula can be used by a person to determine whether he needs to pay or get the basis of the applicable interest rate over a specific period. It is one of the easiest and fastest ways to determine the value of an amount in the future basis the applicable interest rate and tenure. Let’s consider the following examples of using a simple interest calculator.

When The Amount Is Borrowed: Use this formula to determine the amount that needs to be repaid to the lender by applying the annual interest rate. This simple interest formula helps borrowers ascertain the overall amount of borrowing cost.

When The Money Is Lent: If a person has offered an amount to another person to get an increased amount by applying the interest rate. Using this Simple Interest formula, a person can easily get the additional income that is accrued from the Interest.

When The Money Is Invested: If a person has invested a sum of money in money-saving or investment tools like RD, FD, PPF and others, he can adjudge the interest income using this simple interest calculator.

Pros and Cons of Simple Interest

All the pros and cons of simple interest have been documented in the table below:

 Advantages of Simple Interest Disadvantages of Simple Interest The total amount you owe is calculated by adding interest to the original loan amount and the principal decreases as you make payments By paying off the loan sooner, you reduce the amount of interest that you are obligated to pay as per the loan agreement Unlike compound interest, simple interest yields lower results and does not help your money grow exponentially over time Simple interest is not the perfect investment opportunity if you are looking for more significant long-term growth

How to Use Simple Interest Calculator?

An easy-to-use Simple Interest Calculator is the best way for people to determine a future amount that they get or deposit calculated using the amount along with the interest rate. The outcome can be determined in no time after a person enters the principal, rate, and time value.

At a time when there are different types of investments available in the financial sector, this calculator plays a pivotal role by enabling people to easily determine the amount they would get after a certain time at a specific interest rate. Similarly, borrowers can determine the overall cost of borrowing an amount by determining the extra amount they would pay.

Some Major Pluses of Using a Simple Interest Calculator Are:

• One can calculate the simple interest regardless of the currency. Be it the Indian Rupee, US Dollar, Pound, or any other currency, calculating simple interest using a calculator is very easy.
• A person saves a great amount of time by using a simple interest calculator.
• One can utilize several factors available to get a precise estimate of the overall investment. This, in turn, helps in better decision-making.
• Calculating the current worth of money is made easier using a simple interest loan calculator.

What is Compound Interest?

Compound interest is the term used to describe interest that is calculated on both the initial principle and the interest that has accrued over time. It's the interest on interest, to put it another way.

When interest on an investment or loan is compounded, it means that the interest is added to the principal after each compounding period (often monthly, quarterly, or annually), and subsequent interest calculations are based on the updated amount. This causes the value of an investment or the sum owing on a loan to increase exponentially over time.

As it allows for the magnifying of returns or debts over time, compound interest has a substantial impact on the growth of savings or the cost of borrowing.

How to Calculate Compound Interest Formula?

To calculate principal plus interest, this compound interest calculator applies the formula. Given the other known numbers, the same procedure is used to calculate the principal, rate, or time.

P(1 + r/n)nt = A

• In the equation
• A =is the accumulated sum (principal plus interest).
• P= is the principal sum.
• R= equals the annual nominal interest rate, as a decimal.
• R is the annual percentage rate of nominal interest.
• R= R/100
• N= is the number of compounding periods per second.
• T= stands for time in decimal years; for example, 6 months is equal to 0.5 years. To acquire the decimal years, divide your partial year's number of months by 12.
• I= is the interest rate.
• In= stands for natural logarithm.

Pros and Cons of Compound Interest

The pros and cons of compound interest have been documented in the following table:

 Advantages of compound Interest Disadvantages of Compound Interest When you invest your money with compound interest, your returns have the potential to grow exponentially over time. This means that not only do you earn interest on your initial investment, but you also earn interest on the interest that has already been added to your account. Compound interest on debt can become a serious problem if not managed properly. It has the potential to escalate rapidly, pushing you into a dire financial situation Compound interest has the benefit of not requiring a large initial investment. Even small amounts of money can generate significant returns over time

FAQs

1. Is There Any Eligibility Criteria To Use Simple Interest Calculator?

No, there is no such thing. Anyone can use this calculator to determine the interest rate.

2. What Can I Ascertain Using A Simple Interest Calculator?

People can choose to get the interest rate accrued on the principal amount on the invested amount or borrowed amount they have taken on simple interest.

3. Is Simple Interest Good?

In general, simple interest is advantageous when borrowing money. It implies that your interest expenses will be less than they would be if the lender charged compound interest. Simple interest, however, is inferior to compound interest if you are investing or saving your money.

The Conclusion

Whether you are borrowing money from a bank or financial institution or investing money in a savings instrument, by using a Simple Interest Calculator and Compound Interest Calculator, you can easily determine the amount that your endeavour would accrue over a while. This is why you can find such a financial calculator on InvestKraft involved in lending and investment.