Simple Interest is a way of calculating the amount of interest that is to be paid on the principal and is calculated by an easy formula, which is by multiplying the principal amount with the rate of interest and the number of periods for which the interest has to be paid.
Simple Interest Formula (Table of Contents)
Simple Interest Formula
When you take a loan from a Bank or a Financial Institution you are required to return the same along with Interest over the stipulated tenure of the loan. Simple Interest formula is one of the easiest methods of Interest computation which is used for Short-term loans etc and it doesn’t involve compounding of Interest which makes the calculation simple and easy to compute.
Under this Simple Interest formula, Interest is computed only on the amount initially invested and there is no interest on interest as the case with Compound Interest Formula. Simple Interest Equation finds its usage in Car Loans and Other Consumer Loans extended by Banks and Financial Institution. Also, the Interest paid on Saving Banks Account and Term Deposits by Banks is also based on Simple Interest equation.
Examples of Simple Interest Formula
Let’s take a few simples to advanced examples to understand Simple Interest equation:
Simple Interest formula Example #1
ABC lends a sum of $5000 at 10% per annum for a period of 5 years. Compute the Simple Interest and total amount due after 5 years.
Interest Rate: 10% per annum
Time period (in years) = 5
So now we will do the calculation this using the simple interest equation i.e
- Simple Interest Formula = Principal * Interest Rate * Time Period
- Simple Interest=$5000 * 10%*5
Total Simple Interest for 5 years= $2500
Amount due after 5 years=Principal + Simple Interest
- = $5000+$2500
- Amount due after 5 years = $7500.
Simple Interest formula Example #2
Ravi purchased a Microwave Oven from an Electronic Store which is priced at Rs 10000. He financed the same from its lender HDBC Bank. Details as follows:
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Loan Amount: Rs 12000
Loan period: 1 year
Interest: 10% per annum
The frequency of Payment: Monthly
We can compute the Equated Monthly Amount in EXCEL using the PMT function.
Accordingly, the EMI amount which Ravi will have to pay comes out to Rs 879.16 (which includes both interest and Principal amount as well). We can simply observe from the below Amortization schedule of Loan that Interest amount kept decreasing with each payment and Principal Amount kept increasing; however, Monthly Installment remained the same across the tenure of the loan.
Important Points to Note when computing Simple Interest:
- The time period must be in years. In case the same is in a month it should be converted into years as a fraction.
- Interest Rate must be expressed on an Annual Basis, but if the time period is less than a year then it must be adjusted for one year. For instance, if the interest rate is 12% per annum, but the problem pertain pertains to Monthly Interest Rate then it will be 1% (12%/12).
Simple Interest formula in Excel Example #3
Ram took a Car Loan of $500000 from HDBC Bank where interest is payable at 10% for a period of 24 months. The Loan is to be repaid by making monthly equal Payments of $23072.46 (computed using PMT function in Excel)
Schedule of payments Calculated using Simple Interest formula in excel is as follows:
Let’s understand the concept of Simple Interest formula in excel using one more Industry example related to Certificate of Deposits (CD).
Simple Interest formula in Excel Example #4
ABC Bank subscribed to the Certificate of Deposits totaling $20000 issued by Government of India which carries 5% interest per annum. The Certificate of Deposits matures in 6 months.
Below is the calculation of simple interest equation of ABC Bank in excel.
Interest earned by ABC Bank on Certificate of Deposits:
Simple Interest= Principal * Rate* Time period
Thus ABC Bank will earn a total interest of $500 on the Certificates of deposits on maturity i.e. after 6 months.
Simple Interest equation helps financial Institutions and other lenders to calculate the interest that they will earn over the entire tenure of the loan. Also, it helps the borrower as it doesn’t involve compounding of Interest. It is one of the simplest ways of calculating simple Interest and also one of the basic concepts of Interest computation before one learns more advanced Interest Calculation techniques.
Simple Interest Calculator
You can use the following Simple Interest Calculator.
|Simple Interest Formula =||Principal x Interest Rate x Time Period|
|0 x 0 x 0 =||0|
Relevance and Uses of Simple Interest Formula
- Simple Interest equation finds its relevance in the way interest is computed by Banks on Savings Bank Account and Term Deposits held by Depositors. Banks normally compute Interest on a quarterly basis in Savings and Term Deposits.
- Returns computed under Simple Interest will always be less than returns computed under Compound Interest as it ignores the concept of Compounding.
- The Simple Interest formula ensures that the Interest portion is higher in Initial years and subsequently reduced as the tenure of loan progress.
- Simple Interest formula is used computing interest on short-term loans like Car Loans, certificate of deposits and Saving Account and Term Deposits.
Simple Interest Formula Video
This has been a guide to Simple Interest Formula. Here we discuss its uses along with simple to advanced practical examples to understand Simple Interest Formula. Here we also provide you with Simple Interest Calculator with downloadable excel template. You can learn more about Excel Modeling from the following articles –
- Compound Interest Formula with Examples
- Monthly Compound Interest Formula
- Mortgage Formula Calculator
- Fractions in Excel
- Accounting Relevance
- What is Amortization Schedule for a Mortgage?
- Calculate Continuous Compounding
- Basics of Capitalized Interest
- Differences between Mortgage APR vs Interest Rate
- Introduction to Imputed Interest