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About This Calculator
Calculate how much interest you'll earn on savings or pay on a loan over any time period, with options for simple or compound interest. Simple interest is calculated only on the original principal, while compound interest grows on accumulated interest as well. Understanding this distinction is fundamental to making smart decisions about both saving and borrowing.
Quick Tips
- 1 Even a 0.5% rate difference compounds to thousands over a 10-year loan.
- 2 Verify whether your rate is simple or compound — compound grows your cost faster.
- 3 Compare APY, not APR, when evaluating savings accounts to see your true earnings.
Example Calculation
$25,000 at 4.75% compounded monthly for 3 years.
Interest earned: $3,814 | Final balance: $28,814 | Effective annual rate: 4.86%
What Is Simple Interest?
Simple interest is a method of calculating the cost of borrowing or the return on an investment based only on the original principal amount. The formula is straightforward: Interest = Principal x Rate x Time (I = P x R x T). Unlike compound interest, simple interest does not factor in any previously accumulated interest — it is calculated solely on the initial amount. This makes it easy to predict exact interest charges or earnings over any time period.
Simple Interest vs Compound Interest
The key difference between simple and compound interest is that compound interest calculates interest on both the principal and any previously earned interest, creating a snowball effect over time. For example, $10,000 at 5% simple interest earns exactly $500 per year regardless of the term, while the same amount at 5% compound interest (compounded annually) earns $500 the first year but $525 the second year and increasingly more each subsequent year. Over short periods the difference is modest, but over decades compound interest generates dramatically more growth — which is why it is favored for savings and investments.
How to Calculate Simple Interest
To calculate simple interest, multiply the principal amount by the annual interest rate (as a decimal) by the time period in years. For example, a $5,000 loan at 6% annual interest for 3 years produces $5,000 x 0.06 x 3 = $900 in total interest. If the time period is given in months, divide by 12; if in days, divide by 365. The total amount owed or earned at the end of the period is simply the original principal plus the calculated interest.
When Simple Interest Is Used in Practice
Simple interest is commonly used for auto loans, short-term personal loans, and some types of bonds including U.S. Treasury bills. Many car loans in the United States are structured as simple interest loans, where your monthly payment first covers the interest accrued since your last payment and then reduces the principal balance. Student loans during grace or deferment periods also typically accrue simple interest. Understanding when simple interest applies helps you accurately compare loan offers and calculate the true cost of borrowing.
Frequently Asked Questions
Simple interest is calculated only on the original principal: I = P x r x t. Compound interest is calculated on the principal plus previously earned interest, causing exponential growth. Over long periods, compound interest significantly outpaces simple interest.
More frequent compounding earns slightly more. $10,000 at 5% for 5 years yields $12,763 with annual compounding, $12,820 with monthly, and $12,840 with daily. The difference is modest but increases with higher rates and longer periods.
The Rule of 72 is a quick way to estimate how long it takes to double your money: divide 72 by the annual interest rate. At 6%, your money doubles in approximately 72/6 = 12 years. At 8%, it doubles in about 9 years.
Savings accounts and CDs use compound interest (typically daily compounding). Most personal and auto loans also use compound interest (monthly). Credit cards use daily compounding on your average daily balance. Simple interest is rare but used in some auto loans and short-term notes.