The concepts of simple interest and compound interest could confuse you if you aren’t aware of the finer details. Let's look at the differences, including the compound interest rate formula. The simple interest rate is calculated annually on the initial principal amount alone for the entire period.
When you calculate compound interest using the compound interest rate formula, you combine both the principal and the previous interest. An initial principal of Rs. 100 with a simple interest of 10% per year for 5 years would result in a simple interest rate of Rs. 10 per year, with a total amount after 5 years of Rs. 150.
As an alternative, compounding at the same rate after 5 years will result in a total of about Rs. 161. The interest after the 1st year is calculated on Rs. 10. After the second year, the compound interest will be calculated on Rs. 110 instead of Rs. 100, and so on until the loan is paid off. For that same interest rate and principal amount, the amount will be higher after 5 years if compounded.
How to calculate
Simple interest is the interest you pay on a principal amount you borrow
SI = P (Principal amount) × R (Rate of Interest) × T (Time)
Compound Interest is the interest on the principal added to the unpaid interest
P (Principal Amount) (1+r/n) > (nt)
In this formula, n 'refers to number of instances when interest is applied', r 'refers to the interest rate', and t 'refers to the tenor or time'.
Uses of simple interest
Uses of compound interest
Aman Khanna is an experienced financial advisor who is well known for his ability to foretell the market trends as well as for his financial astuteness. He has an MBA in finance from Toronto University as well as years of experience delivering seminars on sound financial practices and debt management.