What is Simple Interest?

Simple interest is calculated only on the original principal amount. It's commonly used for:

• Short-term personal loans
• Car loans
• Certificates of Deposit (CDs)
• Some types of bonds

Formula: SI = P × R × T (Principal × Rate × Time)

Key Characteristics

Main features of simple interest:

• Interest doesn't compound over time
• Linear growth pattern
• Easier to calculate than compound interest
• Common in short-term financing

Typically measured in annual percentage rate (APR)

When to Use Simple Interest

Appropriate scenarios:

• Short-term loans (<1 year)
• Auto loans
• Installment loans
• Certain investment products

Not ideal for long-term investments due to no compounding

Advantages

Benefits of simple interest:

• Predictable payments
• Lower total interest over time
• Easy to understand and calculate
• Transparent cost structure

Preferred for borrowers in short-term scenarios

Simple vs Compound Interest

Simple interest is calculated based solely on the original principal amount, resulting in linear growth over time. In contrast, compound interest is calculated on both the principal and the accumulated interest, leading to exponential growth. Consequently, the total interest accrued with compound interest is typically higher than with simple interest.

Real-World Applications

Common uses include:

• Personal loans between individuals
• Short-term business loans
• Some mortgage products
• Deposit certificates
• Credit card cash advances

Often regulated by usury laws

Calculation Example

If you borrow $10,000 at 5% for 3 years:

• Principal (P): $10,000
• Rate (R): 5% (0.05)
• Time (T): 3 years
• Interest = 10,000 × 0.05 × 3 = $1,500
• Total Repayment: $11,500

Monthly payment: $11,500 ÷ 36 = $319.44

Important Considerations

When using simple interest:

• Verify calculation method in contracts
• Confirm payment schedule
• Check for prepayment penalties
• Understand late payment terms
• Compare APR with compound options

Always read loan agreements carefully