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The Mathematics of Easy Money: Simple Interest
Simple Interest is the most straightforward way to calculate the cost of borrowing or the return on investment. Unlike its more aggressive cousin (compound interest), simple interest plays fair: it only charges you based on the original principal amount, never on the accumulated interest. It is the foundation of short-term car loans, consumer finance, and certificate of deposits.
Decoding the Formula
The "Time" Trap: The formula always expects Time in Years. If you have months, divide by 12. If days, divide by 365. Our calculator handles this conversion for you automatically.
Simple vs. Compound Interest: The Battle
If you invest $10,000 at 10% for 20 years, the difference is staggering:
Simple Interest
Linear growth. Safe, predictable.
Compound Interest
Exponential growth. "The 8th Wonder."
When Is Simple Interest Used?
Car Loans
Most auto loans calculate interest on the principal only, though they amortize it differently.
Personal Loans
Short-term lending from friends or family usually follows the simple interest model to keep things fair and easy.
Certificates of Deposit (Some)
Some short-term CDs pay simple interest at maturity rather than compounding it.
Frequently Asked Questions
What is the Simple Interest formula?
The universal formula is SI = (P × R × T) / 100. P = Principal (starting amount), R = Rate of interest per year, T = Time in years. To find the Total Amount (A), you simply add the interest back to the principal: A = P + SI.
How is Simple Interest different from Compound Interest?
Simple Interest calculates interest ONLY on the principal amount. It is linear. Compound Interest calculates interest on the principal PLUS any accumulated interest. It is exponential ("interest on interest") and grows much faster over time.
Can I calculate interest for months or days?
Yes. Since the "T" in the formula represents years, you simply convert your time frame. For months: T = months/12. For days: T = days/365. Example: 6 months = 0.5 years.
What types of loans use Simple Interest?
Most car loans, short-term personal loans, and some mortgages use simple interest. However, credit cards use compound interest, which is why their debt grows so fast if unpaid.
How do I solve for Principal if I know the Interest?
Rearranging the formula: P = (SI × 100) / (R × T). Example: If you earned $500 interest at 5% over 2 years, your principal was (500×100)/(5×2) = $5,000.
How do I solve for Time?
Rearranging the formula: T = (SI × 100) / (P × R). This tells you how long you need to invest your money to reach a specific interest goal.
Does Simple Interest benefit the borrower or lender?
Simple Interest benefits the borrower. Since interest doesn't compound, the total amount payable is significantly lower than a compound interest loan over the same period. Conversely, lenders/investors prefer compound interest to maximize returns.
What is the "Rule of 72"?
The Rule of 72 estimates how long it takes to double your money using Compound Interest (72 ÷ Rate). For Simple Interest, the rule is 100 ÷ Rate. Example: At 10% simple interest, it takes exactly 10 years to double your money (100 ÷ 10).
Why do car loans seem to cost more than the SI formula predicts?
Many auto loans use "precomputed interest" or add fees into the principal (origination fees, gap insurance). Also, the amortization schedule means you pay more interest upfront, even if it is calculated simply.
Is interest earned on a savings account simple or compound?
Almost all modern savings accounts pay Compound Interest (usually compounded daily or monthly). Fixed Deposits (FDs) or CDs often quote an "Annual Percentage Yield" (APY) which includes compounding, vs an "Interest Rate" which might be simple.
How does inflation affect my "real" interest return?
If you earn 5% simple interest but inflation is 3%, your "real" return is roughly 2%. Simple interest investments (like bonds) are particularly vulnerable to inflation risk over long periods because the payout doesn't scale.
Can I have a negative interest rate?
In theory, yes. In a negative interest rate environment (seen in some European/Japanese central banks), the lender pays the borrower. However, for consumer loans, R is always positive.