What Is Simple Interest?

What Is Simple Interest?

By Charles Joseph | Editor, Financial Affairs
Reviewed by Corey Michael | Senior Financial Analyst

Simple Interest is a quick and easy method of calculating the interest charge on a loan. It is determined by multiplying the daily interest rate by the principal by the number of days that elapse between payments. This type of interest usually applies to automobile loans, short-term loans, savings accounts, certificates of deposit, and most types of bonds.

Related Questions

1. How is Simple Interest calculated?

Simple Interest is calculated using the formula: Interest = Principal x Rate x Time. The principal is the initial amount of the loan, the rate is the annual interest rate, and time is the period for which the money is borrowed, usually in years.

2. Does Simple Interest accumulate over time?

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No, Simple Interest does not accumulate or compound over time. It remains the same throughout the duration of the loan since it is calculated only on the initial amount (principal) that you borrowed.

3. What is the difference between Simple Interest and Compound Interest?

Simple Interest is only charged on the original principal, whereas compound interest is charged on the original principal plus any interest that has previously been added. This means that you end up paying interest on interest with compound interest, causing the total amount of interest paid to grow faster than with simple interest.

4. When is Simple Interest commonly used?

Simple Interest is commonly used with short-term loans, car loans, savings accounts, or any other loan or savings account where interest does not compound.

5. Are there any drawbacks to Simple Interest?

Yes, while Simple Interest is easy to calculate and understand, it may not offer you the most value in the long-term. Because it is not compounded, you may end up earning or owing less than you would with compound interest.