A simple interest rate is the cost of borrowing money without considering the compounding effects. It also refers to the money you earn when depositing or lending money. It only applies to the principal amount and does not include the compounding interest applicable through multiple instances of interest charges or payments.
Understanding the simple interest rate formula is the fundamental concept for gaining financial proficiency. When you know how simple interest works, you can make better financial decisions that help save money. Borrowing loans with a lower interest rate helps save money, while depositing money in places with higher interest rates helps accumulate money over time. In the following sections, we will discuss what a simple interest rate is and learn how to calculate it.
Where is the Concept of Simple Interest Used?
The concept of simple interest is used in multiple instances. That includes times when you borrow money, lend money, or deposit money. When you borrow a loan, you must repay it to the lender with interest, representing the borrowing cost. When lending money, you may set an interest rate in exchange for providing your money to others. When depositing money in an interest-bearing account like a savings account or fixed deposit, the interest rate determines how much money you will earn by letting the bank lend your money to others.
Here, P is the principal amount, r is the rate of interest, and t is the term of deposit or loan in years. That involves multiplying the principal amount with the interest rate and loan or deposit tenure. When using the formula, you must enter the term in the number of years instead of months.
If you want to calculate the interest rate in months, the formula will be:
(P x r x t) ÷ (100 x 12)
To calculate the total amount, which is the total loan cost or the maturity value of a deposit, including interest and principal, use this formula:
FV = P x (1 + (r x t))
Here, FV means Future Value. You can subtract the principal amount from the FV to calculate the interest receivable or payable.
An online simple interest calculator is helpful in calculating interest within seconds without any manual calculations or chance of errors.
Here is a simple interest formula example for deposits:
Instance 1: If you deposit Rs 1 Lakh in fixed deposit for one year at an interest rate of 8%, the simple interest rate will be:
(1,00,000 x 8 x 1) ÷ 100 = Rs 8,000
That means the interest amount you will receive at the FD maturity will be Rs 8,000. The maturity proceeds of the FD mentioned above will be Rs 1,08,000.
Instance 2: If you deposit Rs 8 Lakh in an FD for five years at an interest rate of 6.85%, the simple interest rate earned will be:
(8,00,000 x 6.85 x 5) ÷ 100 = Rs 2,74,000
The interest received at maturity will be Rs 2.74 Lakh. The maturity amount you will receive after five years of deposit will be Rs 10.74 Lakh.
Simple Interest Calculation in Loans
Here is a simple interest formula example for loans:
Instance 1: If you borrow online finance of Rs 5 Lakh at an interest rate of 18% for three years, you can calculate Personal Loan interest payment as follows:
(5,00,000 x 18 x 3) ÷ 100 = Rs 2,70,000
The interest you will pay over the tenure of three years will be Rs 2.7 Lakh. That means the total amount you will repay the lender will be Rs 7.7 Lakh. It will cost Rs 21,389 on a monthly basis.
Instance 2: If you borrow a car loan of Rs 12 Lakh at an interest rate of 7% for five years, calculate the total interest you will pay using this simple interest rate formula:
(12,00,000 x 7 x 5) ÷ 100 = Rs 4,20,000
The total interest you will pay over the loan tenure will be Rs 4.2 Lakh. The total loan cost will be around Rs 16.2 Lakh. It will cost Rs 45,000 on a monthly basis.
It is calculated on the principal amount only for the entire tenure.
It is calculated periodically at regular intervals.
The accumulated interest is not calculated in the simple interest rate formula.
In compound interest accumulates the interest added regularly for the next period.
Interest paid or earned does not increase over time.
Interest payment increases based on the last period’s accumulated principal amount.
The interest accumulation is slower in simple interest than in compound interest. That means simple interest is beneficial when depositing money or making investments, but you must avoid loans with compound interest calculations. As far as calculating these interest types is concerned, simple interest is easier to calculate than compound interest.
Interest rates for personal loans can vary depending on the lender and the terms of the loan. Generally, personal loan interest rates are often based on simple interest. Simple interest is calculated on the principal amount borrowed, and the interest doesn't compound over time. The borrower pays back the original amount borrowed plus the interest charged on that principal.
Compound interest, on the other hand, is not commonly used in personal loans. It's more typical in savings accounts or investments, where the interest earned is added to the principal amount, and subsequent interest is calculated based on that new, larger sum.
Example of Personal Loan EMI using Simple Interest Rate
Example of Personal Loan EMI using Compound Interest Rate
Total balance at end of Year 1: Rs. 300,000 + Rs. 33,000 = Rs. 333,000
Year 2:
Initial balance: Rs. 333,000 (balance at the end of Year 1)
Interest earned: 11% of Rs. 333,000 = Rs. 36,630
Total balance at end of Year 2: Rs. 333,000 + Rs. 36,630 = Rs. 369,630
This pattern continues with each year's interest being calculated based on the new total balance, resulting in accelerated growth due to compound interest.
Disclaimer:The interest rate and final amount mentioned is just an example. It might change depending on how much money you're borrowing.
1. What is the formula of rate in simple interest?
The simple interest rate formula is (P x r x t) ÷ 100.
2. Is there an alternative formula for computing the maturity amount of a fixed deposit when the deposit tenure is expressed in months?
The formula to calculate a simple rate is (P x r x t) ÷ 100. Here, you must enter the tenure in years. If you want to calculate the interest in months, use this formula instead: (P x r x t) ÷ (100 x 12).
3. What formula should be used to calculate simple interest when the tenure is specified in months?
The formula to calculate simple interest in months is (P x r x t) ÷ (100 x 12).
4. What's the role of principal, rate, and time in this calculation?
You must enter these variants in the simple interest rate formula to calculate the simple interest rate.
5. How does a simple interest rate differ from a compound interest rate?
The major difference between simple interest and compound interest is that simple interest calculates interest on the principal amount only. In contrast, compound interest calculates interest on the principal amount that accumulates interest over a period.
Katyaini is a finance expert with a focus on the non-banking financial sector, bringing over 8 years of experience in NBFC. She specializes in simplifying complex financial concepts for readers, helping them navigate the NBFC landscape. Outside of work, she is passionate about travelling.
