Simple Interest
Interest that is charged on the principal alone and never compounds.
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Formula
How the calculation works
Simple interest is a straight line because the base never moves. The principal stays at 10,000 and each year adds the same 8%, or 800, so three years bring 2,400 and six years bring 4,800 exactly. Doubling the term doubles the interest, which is a property compound interest does not have.
The rate is per year, so three years at 8% is 24% of the principal in total, not 8%. Because the formula multiplies principal, rate and time, rate and time are interchangeable: 8% for three years gives the same as 3% for eight years, which is a useful check that the inputs are the right way round.
This matches most short fixed-term loans, some car finance and the simple interest written into certain contracts. It diverges from compound the longer the term and the higher the rate: on 10,000 at 8% over thirty years, simple interest is 24,000 while compounding adds over 90,000. The tool allows a zero principal or a zero term and then reports no interest, which is correct.
Common mistakes
- Using simple interest on a balance that compounds, such as a credit card or a long savings account, which understates the cost badly once the term is long.
- Reading 8% over three years as 8% in total rather than 24%; the rate is annual, so it multiplies by the term.
- Assuming it stays simple after the interest is reinvested. Simple interest is only simple while the interest is paid out and not added back to the principal.
When to use it
- Use it for a short fixed-term loan or a deposit where the interest is paid out rather than reinvested, or where a contract states simple interest.
- For savings left to grow, or any debt that charges interest on interest, it is the wrong tool; use the compound interest calculator, which is where the two diverge sharply.
Worked example
10,000 at 8% simple over three years earns 2,400, for 12,400.
Common questions
How is it different from compound?
Simple interest earns nothing on the interest; compound does. Over long periods the gap becomes large.
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