What is Simple Interest?

Interest is basically the extra money you either pay when you borrow or earn when you lend or deposit. For example, you pay interest on loans or credit cards, but you earn interest when you keep money in a savings account or fixed deposit.

Simple interest is the easiest type of interest to understand. It’s calculated only on the original amount (the principal) and does not change over time. This means your interest stays the same every year — it doesn’t “grow on itself” like compound interest does.

The Simple Interest Formula

The formula is:

Simple Interest = Principal × Rate × Time

Or, in short: I = P × r × t

• P = the money you borrowed or invested (principal)

• r = the yearly interest rate (example: 5% = 0.05)

• t = time in years

Example of Simple Interest

Let’s say you borrow $10,000 at 5% interest per year for 5 years.

1. First, find the interest for one year: $10,000 × 0.05 = $500

2. Now multiply by 5 years: $500 × 5 = $2,500

So, after 5 years, you’ll pay back:
$10,000 (principal) + $2,500 (interest) = $12,500

Simple Interest for Shorter Periods

Sometimes interest is calculated monthly or daily. In that case, the formula is written as:

I = P × r × n

Where:

• r = interest rate per period (month/day)

• n = number of periods

👉 Example: $10,000 loan, monthly rate of 5%, for 12 months:
$10,000 × 0.05 × 12 = $6,000 interest.
So, repayment = $16,000.

Where Do You See Simple Interest?

• Short-term personal or business loans

• Some bonds that pay fixed interest (coupon)

• A few dividend-paying investments

💡 For borrowers, simple interest is great because you only pay on the original loan.
💡 For investors, it’s not so great — your money won’t grow as much compared to compound interest.

Simple vs. Compound Interest

Here’s the big difference:

• Simple Interest: You pay/earn interest only on the original money.

• Compound Interest: You pay/earn interest on the original money plus any interest that has already been added.

Quick Example:

• Simple interest loan → $12,500 total after 5 years.

• Compound interest loan → $12,833.59 total after 5 years (slightly higher).

So:

• As a borrower, you’d prefer simple interest (cheaper).

• As an investor, you’d prefer compound interest (higher returns).