Simple Interest (SI) 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.
Formula to Calculate Simple Interest (SI)
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. It is one of the easiest methods of interest calculation which is used for short-term loans etc and it doesn’t involve compounding of interest which makes the calculation simple and easy to calculate.
Here, interest is calculated only on the amount initially invested and there is no interest in interest as the case with compound interest formula. Si Formula finds its usage in car loans and other consumer loans extended by banks and financial institutions. Also, the interest paid on savings bank accounts and term deposits by banks is also based on a simple interest.
ABC lends a sum of $5000 at 10% per annum for a period of 5 years. Calculate 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 = 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.
Ravi purchased a microwave oven from an electronics store that is priced at Rs 10000. he financed the same from its lender hdbc bank. Details as follows:
loan amount: Rs 12000
loan period: 1 year
interest: 10% per annum
The frequency of payment: monthly
We can calculate 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 the principal amount kept increasing; however, the monthly installment remained the same across the tenure of the loan.
Important Points to Note when calculating 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 pertains to the monthly interest rate then it will be 1% (12%/12).
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 (calculated using PMT function in Excel)
Schedule of payments calculated using SI formula in excel is as follows:
Let’s understand the concept of SI formula in excel using one more industry example related to Certificate of Deposits (CD).
ABC Bank subscribed to the certificate of deposits totaling $20000 issued by the government of India which carries 5% interest per annum. The certificate of deposits matures in 6 months.
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 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
- The simple interest finds its relevance in the way interest is calculated by Banks on savings bank account and term deposits held by depositors. Banks normally calculate interest on a quarterly basis in savings and term deposits.
- Returns calculated under simple interest will always be less than returns calculated under compound interest as it ignores the concept of compounding.
- SI formula ensures that the interest portion is higher in Initial years and subsequently reduced as the tenure of loan progress.
- It is used to calculate interest on short-term loans like car loans, certificates of deposits and savings account and term deposits.
Simple Interest Formula Video
This has been a guide to Simple Interest Formula. Here we learn how to calculate simple interest along with some practical examples. Here we also provide you with Simple Interest Calculator with a 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