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What is Compound Interest & Simple Interest: How to Calculate It

  • Highlights

  • Simple interest is calculated on the principal only

  • With compound interest, you earn/pay interest on interest

  • Avoid compound interest loans to save money long-term

  • Pick the Bajaj Finserv Personal Loan to borrow affordably

Whether it is an investment or loan, the way in which the interest is calculated on the offering is of key importance. This ultimately dictates the total earnings or cost of the undertaking. While there are a few ways to calculate interest, for the sake of simplicity, consider the two main types. On the one hand, you have simple interest and on the other you have compound interest. Both of these have stark differences, which are especially evident when the two are applied to real-world scenarios. Remember that for investments, simple interest will always result in a lower yield when compared to compounding interest.

However, in the case of a loan, interest calculated at a simple interest rate will end up being lower in comparison to interest calculated at a compounding interest rate. In fact, compound interest with credit is usually applicable to penalties or outstanding balance. Here, the total amount payable continually grows based on how long it is left unpaid. This is also where the principle of a compounding period comes into play, and it is useful when estimating the total compound interest payable.

With a basic overview of these two important interest types, here’s a deep delve into the simple and compound interest meaning, the compound interest and simple interest formula, and the ways to calculate both.

Additional Reading: How You Can Use a Personal Loan Calculator

What is Compound Interest?

Compound interest calculation is quite different from simple interest mainly because in this case, you’re calculating interest on interest. Here, the interest payable is calculated based on the compounding period, which is the tenor, and then added to the principal borrowed. As such, you end up paying a higher amount or earning more when the instrument in question follows a compound interest calculation.

How Can You Calculate Simple Interest Online and Offline?

Learning how to calculate simple interest online and offline is very simple. For the offline method, here is the formula to use.

Simple interest= P * I * N

P = Principal
I = Yearly interest rate
N = Tenor in years

The value for ‘I’ can be calculated by dividing the interest rate offered by 100. Here’s a simple interest formula example to consider.

Simple interest formula example

For a loan of Rs.1.5 lakh, repayable over a tenor of 3 years at an interest rate 12%, the loan variables are:
      P = 1,50,000
      I = 12/100
      N = 3

Simple interest is:
      Simple interest= 1,50,000 * 0.12 *3
      Simple interest= 54,000

To calculate it online, you simply have to use a free online calculator. These provisions are available easily with a quick search and all you need to do is input the values of the variables.

Additional Read: How to Calculate Your Personal Loan EMI Using Excel

How Can You Calculate Compound Interest?

Calculating the compound interest manually can be a bit tricky because it includes the number of compounding periods in a year. As such, the value of this variable has the potential to change and leaves room for error. To go about this calculation, this is the formula to follow.

    Compound interest = P[(1+i)n −1]

Here,

        P = Principal
        i = yearly interest rate
        n = number of compounding periods each year

Considering the above example, here’s the total compounded interest for the same tenor and interest rate with annual compounding.

Year Opening Balance (P) Interest payable (I) Closing balance (P+I)
1 Rs.1,50,000 Rs.18,000 Rs.1,68,000
2 Rs.1,68,000 Rs.20,160 Rs.1,88,160
3 Rs.1,88,160 Rs.22,579 Rs.2,10,739
Compounded interest Rs.60,739

As an alternative to using a compound interest calculator, Excel is better than manual computations as here, you only need to ensure you’re feeding in the formula correctly and entering data in the cells accurately.

Both simple and compound interest are basic financial concepts you should know, irrespective of whether you want to borrow or invest. Understanding the compound and simple interest formula can give you invaluable insights and help you plan your finances for years to come. This knowledge can improve your ability to make sound borrowing and repayment decisions that can not only save you money, but also keep you from potential debt traps with best personal loan interest rates available.

Moreover, with the monthly compound interest formula and the annual compound interest formula, you can calculate safe estimates of what you’re expected to pay, if the situation ever calls for it. Such foresight and preparation can work in your favour. Similarly, with loan instruments, picking the right lender also works in your favour.

The Bajaj Finserv Personal Loan can be the perfect fit for you if you’re looking for a high-value sanction available on affordable terms. With this loan, you can be approved for up to Rs.25 lakh at an attractive interest rate and for a flexible tenor of up to 60 months. What’s more, using the personal loan calculator, you can accurately know exactly how much your total outgo will be based on the terms available to you. In the loan calculator, the simple interest formula is built-in, but it also accounts for the reducing principal and so, your interest payment is less than if it were computed at a flat rate. Additionally, there are no hidden charges with this loan, thus ensuring a completely transparent borrowing experience. For instant approval and same-day disbursal, check your pre-approved offer at the earliest!

DISCLAIMER:
The content of this document is meant merely for information purposes. The personal loan features mentioned in this article are subject to updation, completion, revision, verification and the same may change materially based on policy revisions. For more details, please visit our Personal Loan terms and conditions page here.

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