We all have lent and borrowed money, and we all have calculated the Interest on it. Still, many of us do not know the difference between Simple Interest and Compound Interest.
Interest simply refers to additional money as a charge for borrowing money. Simple Interest and Compound Interest are the two methods of calculating Interest.
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Key Differences –
Simple Interest –
- Simple Interest, as the name suggests, is a very simple way of calculating Interest. Simple Interest calculates Interest on a particular principal amount at some rate of Interest.
- The Principal amount is the borrowed amount, and it stays the same.
- Simple Interest stays the same throughout.
- Simple Interest is of two types: Ordinary Simple Interest and Exact Simple Interest.
Compound Interest –
- Compound Interest is a comparatively complex method of calculating Interest.
- Compound Interest calculates Interest on Principal Amount + Interest.
- Because Compound Interest takes previous Interest into account, the Principal Amount changes every time.
- Compound Interest does not stay the same throughout.
- Compound Interest is also of two types: Periodic Compounding and Continuous Compounding.
Comparison Between Simple Interest And Compounded Interest
| Parameter | Simple Interest | Compound Interest |
|---|---|---|
| Meaning | Simple Interest is a very easy method of calculating Interest. It calculates Interest on the principal amount at a given interest rate. | Compound Interest is a little complex method of calculating Interest. It calculates Interest on the principal amount + accumulated Interest.. |
| Principal Amount | The principal amount stays the same in Simple Interest. | The principal amount keeps on changing in Compound Interest. |
| Interest | Interest is the same in Simple Interest. | Interest keeps on changing in Compound Interest. |
| Types | It is of two types: Ordinary Simple Interest and Exact Simple Interest. | It is of two types: Periodic Compounding and Continuous Compounding. |
| Difficulty level | It is very easy to calculate Simple Interest. | It is a little complex to calculate Compound Interest. |
| Charges Interest on | It charges interest on the Principal amount. | It charges interest on the Principal amount + accumulated interest. |
| Formula | The formula for Simple Interest is SI = (P * T * R)/100 | The formula for calculating Compound Interest is C.I. = P(1+R/100)^t |
Major Differences Between Simple Interest And Compound Interest
What exactly is Simple Interest?
Simple interest is a very simple method of calculating interest. Simple interest calculates interest for a particular amount of money at a given Interest rate.
For example, suppose you borrowed money from someone and agreed to a rate of 6 percent as an Interest Rate, then interest will be calculated at 6 percent on that principal amount.
Simple interest stays the same, and its principal amount also stays the same. Simple interest is of two types: Ordinary Simple Interest and Exact Simple Interest.
Ordinary Simple Interest calculates money for 365 days irrespective of a year being a leap year. On the other hand, Exact Simple Interest calculates Simple Interest for 365 days in case of a normal year and for 366 days in case of a leap year.
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The Formula for Simple Interest –
SI = (P * T * R)/100
Here,
P refers to Principal Amount
T refers to Time (generally in years)
R refers to Interest Rate
What exactly is Compound Interest?
Compound Interest is a little complex method of calculating interest. This is because it takes the principal amount and the interest accumulated to calculate the interest. Because of this reason, the principal amount keeps on changing as the interest keeps on adding.
Compound Interest, like Simple Interest, is also of two types: Periodic Compounding and Continuous Compounding. Periodic Compounding calculates interest for different intervals and adds it back to the principal amount.
For example, different periods could be annual, semi-yearly, monthly, etc.; continuous Compounding calculates interest for the shortest possible period and uses a log-based formula.
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The Formula for Compound Interest in case of annual compounding –
C.I. = P(1+R/100)^t
Here,
P = Principal Amount
R = Interest rate
t = Number of years
Formula for Compound Interest in case of more than one compounding/year –
C.I. = P(1+r/n)^nt – P
Here,
P = Principal Amount
r = Interest rate
n = Number of times interest is compounded in a year
t = Number of years.
Contrast Between Simple Interest And Compound Interest
Meaning
- Simple Interest – Simple Interest is a very easy method of calculating interest. It calculates interest on the principal amount at a given interest rate.
- Compound Interest – Compound Interest is a little complex method of calculating interest. It calculates interest on the principal amount + accumulated interest.
Difficulty
- Simple Interest – Simple Interest is easier to calculate Interest than Compound Interest.
- Compound Interest – Compound Interest is a little more difficult method of calculating Intertest than Simple Interest.
Types
- Simple Interest – Simple Interest is of two types: Ordinary Simple Interest and Exact Simple Interest.
- Compound Interest – Compound Interest is of two types: Periodic Compounding and Continuous Compounding.
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Types of Simple Interest –
- Ordinary Simple Interest – Ordinary Simple Interest calculates interest for a general 365 days, even if it’s a leap year.
- Exact Simple Interest – As the name suggests, Exact Simple Interest calculates interest for 365 days in case of a normal year and 366 days in case of a leap year.
Types of Compound Interest –
- Periodic Compounding Interest – Periodic Compounding Interest calculates interest annually, semi-yearly, and quarterly. There is no difference between compounding interest and periodic compounding interest.
- Continuous Compounding Interest – Continuous Compounding Interest calculates interest infinite times, every time, or basically for the shortest period possible. It is very complex and is generally not used.
Principal Amount
- Simple Interest – The Principal Amount stays the same in Simple Interest.
- Compound Interest – The Principal Amount does not stay the same in Compound Interest.
Interest
- Simple Interest – The Interest is the same throughout Simple Interest.
- Compound Interest – The interest changes every time in Compound Interest.
Charging Of Interest
- Simple Interest – Interest is charged on the principal amount in the case of Simple Interest.
- Compound Interest – Interest is charged on the principal amount and the accumulated profit in the case of Compound Interest.
Formula
- Simple Interest – The formula for calculating Simple Interest is S.I. = (P * T * R)/100
(Here, P refers to Principal Amount, T refers to the time (generally in years), and R refers to Interest Rate)
- Compound Interest – The formula for calculating Compound Interest is C.I. = P(1+R/100)^t (Here, P = Principal Amount, R = Interest rate, t = Number of years)
Rate Of Return
- Simple Interest – The rate of return is low in Simple Interest as compared to Compound Interest.
- Compound Interest – The rate of return is higher in Compound Interest compared to Simple Interest.
Uses
- Simple Interest – Simple Interest is used in different types of loans, such as
- Compound Interest – Compound Interest is also used in different types of loans such as mortgages, vehicles, etc.
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Uses of Simple Interest –
- Consumer Loans
- Car Loans
- Certificate of Deposit
- Discounts on Early Payments.
Uses of Compound Interest –
- Mortgage Loans
- Vehicle Loans
- Equipment Loans
- Hard Money Loans
Conclusion
Simple Interest and Compound Interest are the two methods of calculating interest. Simple interest calculates interest on a principal amount at a given interest rate. The principal amount and interest amount stay the same in Simple Interest.
Compound Interest calculates interest on the principal amount and accumulated interest. Thus, the principal and interest amounts change every time in Compound Interest.
Frequently Asked Questions (FAQs)
Q1. What is the formula for Simple Interest and Compound Interest?
The formulas for Simple Interest and Compound Interest are
The formula for Simple Interest
The formula for calculating Simple Interest is S.I. = (P * T * R)/100
(Here, P refers to Principal Amount, T refers to the time (generally in years), and R refers to Interest Rate)
The formula for Compound Interest
The formula for calculating Compound Interest is C.I. = P(1+R/100)^t (Here, P = Principal Amount, R = Interest rate, t = Number of years)
Q2. What are the major differences between Simple Interest and Compound Interest?
The major differences between Simple Interest and Compound Interest are –
1. Simple interest is a comparatively easier method of calculating Interest than Compound Interest.
2. S.I. Calculates interest on the principal amount, whereas C.I. calculates interest on the principal.
3. The Principal amount stays the same in Simple Interest while the principal amount keeps changing in Compound Interest.
Q3. What is the difference between Ordinary Simple Interest and Exact Simple Interest?
The main difference between Simple Interest and Compound Interest is that the former considers 365 days in a year, even in a leap year, but the latter considers 365 days in a normal year and 366 days in a leap year.
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