Premium Metal
0% Forex & Travel
Lifetime Free
10X Rewards
UPI Cards
Fuel & Utility
Showstopper
Credit Builder
More

Notifications

  • As per amendment in the Income Tax Rules, PAN or Aadhaar are to be mandatorily quoted for cash deposit or withdrawal aggregating to Rupees twenty lakhs or more in a FY. Please update your PAN or Aadhaar. Kindly reach out to the Bank’s contact center on 1800 10 888 or visit the nearest IDFC FIRST Bank branch for further queries.

  • Activate your Credit Card within minutes and enjoy unlimited benefits

  • One FASTag, three payments:Toll, fuel and parking

    The only FASTag with triple benefits

Personal Loan

Simple Interest Explained: A Clear Distinction from Compound Interest

Key Takeaways

  • Simple interest is calculated only on the principal amount, and remains fixed throughout the loan term, making it easy to calculate and understand.
  • Unlike compound interest, which is calculated on both the principal and accumulated interest, simple interest remains constant and is easier for short-term loans like car loans and personal loans.
  • Simple interest is typically used for personal loans, car loans, and certain business loans, providing borrowers with predictable costs and clear repayment structures.
24 Dec 2024 by Team FinFIRST
Simple Interest Definition

    

What is Simple Interest?
 

Simple interest is a technique used to calculate the proportion of interest paid on a sum over a set time period at a set rate.

The principal amount remains constant in simple interest. Simple interest is a straightforward and easy technique for calculating interest in money. Interest is always applied to the initial principal amount under the simple interest method, and the rate of interest is the same for each time cycle. When we deposit money in a bank, the bank pays us interest on our investment. Banks charge various sorts of interest, one of which is simple interest.

After understanding what simple interest is, one may want to know what the formula for simple interest is. The rate of interest is always in terms of a percentage, so it is always divided by 100. 

What is a simple interest in terms of a loan?
 

Car loans and short-term instant personal loans are the only loans that use the simple interest computation. This computation is also used in a few mortgages, the most notable of which is the biweekly loan. Paying interest relatively frequently advances the payoff date, which is one reason biweekly mortgages help debtors pay their mortgages off faster.

How to calculate simple interest for a loan?
 

Because simple interest is calculated regularly, individuals who repay their loans on time or in advance each month gain the most. For example, for a principal amount of ₹15,000 at an annual interest rate of 5%, if you make a payment of ₹300 on May 1, ₹238.36 will be applied to the principal. On April 20, if you made the identical payment, ₹258.91 would be applied to the principal. Your principal amount will reduce faster if you never miss a payment, and you will pay off the loan quicker than the initial estimate.

The simple loan calculation when you do not pay the amount on time is equally simple. Using the identical loan example, if your bill is due on May 1 and you settle it on May 16, you will be charged ₹92.46 in interest for 45 days. This implies that just ₹207.54 of your ₹300 payment will apply to the principle. Because you decided not to pay down the principal at the projected rate, your last payment will be more than the original estimate if you continuously pay late during the term of the loan. So, the more punctual you are with repaying your loan, the less you pay in the long run.

Simple Interest Formula
 

To calculate simple interest on a monthly basis, you use the formula:

Simple Interest= (P X R X T) / 12 X 100

Here,

P is the principal amount

R is the annual interest rate (as a percentage)

T is the time in months

For example, if you borrow Rs. 10,000 at an annual interest rate of 6% for 6 months, the formula becomes:

Simple Interest= (10,000 X 6 X 6) / 12 X 100 = Rs. 300

This gives you the simple interest accrued over 6 months, which would be Rs. 300.

Calculation Examples with Step-by-step Solutions (Monthly)
 

Example 1: Calculate simple interest on a loan
 

Let’s say you take a loan of Rs. 50,000 at an annual interest rate of 8% for 2 years (24 months).

To calculate the monthly simple interest, we use the formula:

Simple Interest (monthly) = (P X R X T) / 12 X 100

Now, let’s use the values in the formula:

Simple Interest = (50,000 X 8 X 24) / 12 X 100

= 9,600,000 / 1,200 = Rs. 8,000

So, the simple interest for 24 months is Rs. 8,000.

Example 2: Interest on a Savings Deposit
 

If you deposit Rs. 10,000 in a savings account offering 5% simple interest for 1 year,

To calculate the monthly simple interest:

Simple Interest: (P X R X T) / 12 X 100

Now, applying the values -

Simple Interest = (10,000 X 5 X 12) / 12 X 100

= 600,000 / 1,200 = Rs. 500

So, the interest earned after 12 months is Rs. 500.

Simple Interest Vs Compound Interest

Simple Interest

Compound Interest

Calculated only on the principal amount

Calculated on both principal and accumulated interest

Easy to calculate and understand

More complex, grows faster over time

Commonly used for short-term loans

Used for long-term loans

Total interest amount remains fixed

Interest increases over time due to compounding

 

Types of Loans That Use Simple Interest
 

Simple interest is commonly applied to personal loans, car loans, and some business loans. These loans are popular because they’re easy to understand – borrowers can see exactly how much interest they will pay. Unlike compound interest loans, simple interest loans don’t charge interest on the interest itself, making them a better choice for many borrowers.

IDFC FIRST Bank offers great rates on Personal Loans and ensures that its customers get the best experience when doing business with them. They use a combination of both simple and compound interest to calculate the rate of interest on your loan, giving you the best deal possible. If you want to know what is compound interest and simple interest and understand how interest is calculated on your loan, you can learn more about it on the IDFC FIRST Bank website or mobile banking app.

Hopefully, your questions regarding what a simple interest has been answered. If you have questions like what principal in simple interest is or what is the simple interest instalment formula, you can head over to the IDFC FIRST Bank website, where these topics have been covered.

Frequently Asked Questions

How is simple interest different from compound interest?

Simple interest is calculated only on the principal amount, meaning it stays the same throughout the loan period. Compound interest is calculated on both the principal and accumulated interest, which makes it grow faster over time.

What happens if the interest rate changes over time?

When the interest rate changes over time, simple interest is adjusted based on the new rate. The recalculated amount applies only to the remaining loan period, ensuring transparency and ease of calculation.

What is the simple interest principle?

The simple interest principle refers to the original sum of money that is borrowed. The interest is calculated only on this principal amount for the entire duration of the loan.

What is the use of simple interest?

Simple interest is often used in short-term loans like personal loans and car loans. It becomes easier for borrowers to understand exactly how much interest they’ll be paying over a period of time.

Disclaimer

The contents of this article/infographic/picture/video are meant solely for information purposes. The contents are generic in nature and for informational purposes only. It is not a substitute for specific advice in your own circumstances. The information is subject to updation, completion, revision, verification and amendment and the same may change materially. The information is not intended for distribution or use by any person in any jurisdiction where such distribution or use would be contrary to law or regulation or would subject IDFC FIRST Bank or its affiliates to any licensing or registration requirements. IDFC FIRST Bank shall not be responsible for any direct/indirect loss or liability incurred by the reader for taking any financial decisions based on the contents and information mentioned. Please consult your financial advisor before making any financial decision.

The features, benefits and offers mentioned in the article are applicable as on the day of publication of this blog and is subject to change without notice. The contents herein are also subject to other product specific terms and conditions and any third party terms and conditions, as applicable. Please refer our website www.idfcfirstbank.com for latest updates.