2 min read
05 Jan 2021

Interest, whether earned or incurred, is an essential part of any financial undertaking. It applies to both investments and loans. For investments, the interest indicates the amount you can earn with the instrument. On the other hand, interest is how much you’re liable to pay the lender for borrowing the chosen amount with loans. There are two main types of interest applicable here: simple interest and compound interest. Knowing the difference between compound and simple interest is important for everyone.

Additional Read: How Do Interest Only Loan Work

However, while investors are acquainted with the effect of compound interest, borrowers may not be well-informed. So, the focus here is to understand how simple interest and compound interest impact borrowing. When you take a loan, the way your interest gets calculated plays a crucial role in your total outgo. With equal terms, when comparing simple interest vs compound interest, you’ll find that the simple interest option will always result in lower outgo.

With loans, compound interest is usually applied to outstanding credit payments. As a result, you end up paying a lot more in comparison, which is why you should try to avoid it at all costs. To better understand the difference between compound and simple interest, consider the definitions of these terms, simple and compound interest formula.

## What is simple interest?

To put it briefly, simple interest is the interest calculated as a percentage of the principal amount for a given period. In this case, none of the variables undergoes any change and remains constant all through. It is the quickest way to know the interest payable on a loan, and manual calculations are quite easy.

Additional Read: How to calculate Loan EMI on calculator

## What is the simple interest formula?

Simple interest is calculated as a percentage of the principal wherein the period remains constant. As such, the simple interest formula is:

SI = P * i * n

Here,
P = principal
i = annual interest rate
n = tenor in years

To give you a better understanding of SI, here is the formula in action. Consider a loan of Rs. 1.2 lakh taken at an interest rate of 13% for a tenor of 3 years. So, based on these variables:

SI= 1,20,000*0.13*3
SI= 46,800

This is the total interest payable after 3 years for the given principal amount.

Additional Read: Compute Your Simple Interest Amount with Simple Interest Calculator

## What is compound interest?

Compound interest is hugely different from simple interest because here, you incur interest on interest. With compound interest, interest is charged on the revised principal, which contains the prior interest incurred. Here, the value of the principal changes based on the compounding period. Compounding interest is used to calculate interest payable in the case of certain types of credit. It is important to note that the total payable with compounding interest will be higher than that payable with simple interest.

## What is the compound interest formula?

To Calculate compound interest, the formula is as follows.

CI = P[(1+i)n −1]

Here,
P = Principal
i = annual interest rate
n = compounding period in years

Considering the same case as above, on a loan of Rs. 1.2 lakh taken for three years at a 13% rate, below is the CI for three years. Do note that for this example, the interest is compounded annually.

 Year Opening Balance (P) Interest payable (I) Closing balance (P+I) 1 Rs. 1.2 lakh Rs. 15,600 Rs. 1,35,600 2 Rs. 1,35,600 Rs. 17,628 Rs. 1,53,228 3 Rs. 1,53,228 Rs. 19,919 Rs. 1,73,148 Compound interest Rs. 53,148

As you can see, the difference between CI & SI for three years is Rs. 6,348. The formula of difference between CI and SI is ‘CI-SI’, which will get you the above-mentioned value.

Additional Read: How you can use a Personal Loan Calculator

## Simple Interest Vs Compound Interest

The main difference between compound and simple interest is that the principal amount changes based on the compounded period with compound interest. With simple interest, all the variables, including the principal, remain static all through the period. Another key difference to note is that compound interest will yield higher earnings with investments but conversely increase the cost of borrowing in the case of credit. However, with simple interest, loans will have lower interest outgo, and investments will yield less in comparison.

Pitting simple interest vs compound interest helps you understand financial instruments and how they impact your financial health over time. While compound interest is common with investments, you should know that neither compound interest nor simple interest is the norm with loans. Loans like Bajaj Finserv Personal Loan make use of a reducing balance calculation in which the principal reduces over the tenor with each EMI payment made. Check your eligibility and apply for personal loan online. Further, you can use the Loan EMI calculator to see how this calculation mode even betters simple interest calculations.

Bajaj Finserv offers funding up to Rs. 40 lakh for a tenor of up to 96 months. You can enjoy loan perks such as expedited loan processing and complete loan disbursal within 24 hours with a sound financial profile. This makes it a loan you can count on, even when faced with an emergency. To enjoy the benefits of this offering, check your pre-approved offer today for a hassle-free experience.

DISCLAIMER:
While care is taken to update the information, products, and services included in or available on our website and related platforms/websites, there may be inadvertent inaccuracies or typographical errors or delays in updating the information. The material contained in this site, and on associated web pages, is for reference and general information purpose and the details mentioned in the respective product/service document shall prevail in case of any inconsistency. Subscribers and users should seek professional advice before acting on the basis of the information contained herein. Please take an informed decision with respect to any product or service after going through the relevant product/service document and applicable terms and conditions. In case any inconsistencies observed, please click on reach us.

*Terms and conditions apply

## Frequently asked questions

What is difference between CI and SI?

Compound interest and simple interest differ in how interest is calculated. Simple interest applies to the original principal amount over time, while compound interest considers both the initial principal and previously accrued interest, resulting in exponential growth. Compound interest generally yields higher returns over extended periods, unlike the linear growth of simple interest.

What is the formula of SI and CI?

The formulas for Simple Interest (SI) and Compound Interest (CI) are:

1. Simple Interest (SI): SI=P×R×T÷100, where P is the principal amount, R is the rate of interest, and T is the time in years.
2. Compound Interest (CI): CI=P×(1+100R​)TP where P is the principal amount, R is the rate of interest, and T is the time in years.
Who uses simple interest?

Simple Interest (SI) is commonly used in various financial transactions. Individuals, banks, and financial institutions use SI for straightforward interest calculations on loans, deposits, or investments. It is prevalent in scenarios where interest is applied only to the initial principal amount, without considering any accrued interest over time, as in compound interest.

What is maturity value?

Maturity value is the final amount that a financial instrument, such as a bond or certificate of deposit, attains at the end of its term. For time-based investments, it includes both the principal amount and any accrued interest. The maturity value is realized when the investment reaches its specified maturity date.

Why is compound interest used?

Compound interest is used to enhance investment returns by calculating interest on both the initial principal and the accumulated interest from previous periods. This compounding effect allows investments to grow exponentially over time. It is commonly employed in savings accounts, loans, and investments to maximize long-term financial growth.

What is principal in simple interest?

In simple interest, the principal refers to the initial amount of money invested or borrowed. It is the original sum upon which interest calculations are based. The interest is calculated as a percentage of this principal amount over a specified period, without considering any interest accumulated over time.

Show More Show Less