What will be the difference between simple interest and compound interest?

Simple interest refers to the interest which is calculated on the principal amount that is borrowed or invested by the person. In contrast, compound interest is the interest calculated on the principal amount borrowed or invested by the person along with the previous period’s accumulated interests.

Interest is the fees paid by the borrower to the lender for borrowing money. For example, banks charge interest on the loans taken by the customers. People deposit money in the banks to earn interest on the amount deposited. Higher interest rates are the opportunity for investors to earn higher rates of return.

There are two ways to calculate the interest on the principle: Compound and Simple interestSimple InterestSimple interest (SI) refers to the percentage of interest charged or yielded on the principal sum for a specific period.read more.

Table of contents

What is Simple Interest?

Simple interest, as the name suggests, is simple in the calculation and understanding. It is the amount that the lender charges the borrower on only the principal loan.

The formula to Calculate Simple InterestCalculate Simple InterestSimple Interest (SI) is a way of calculating the amount of interest that is to be paid on the principal and is calculated by multiplying the principal amount with the rate of interest and the number of periods for which the interest has to be paid.read more is:

What will be the difference between simple interest and compound interest?

Where SI is Simple Interest

  • P is Principal
  • R is the rate
  • And T is the time for which the loan is given.

The amount owed at the end of the period is given by

A = SI + P or A = PRT/100 + P

What will be the difference between simple interest and compound interest?

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What is Compound Interest?

Compound interest is earned on the principal amount and the accrued interest. Compound interest depends on the frequency of compounding, i.e., the interest can be compounded daily, monthly, quarterly, half-yearly or annual, etc.

The formula to calculate the amount earned when the principal is compounded is given as:

What will be the difference between simple interest and compound interest?

Where A is the Amount,

  • P is the principal,
  • R is the rate of interest.
  • T is the time for which the principal is owed

Thus, the Compound Interest is calculated = A – P = P (1 + r/100)T – P

It can be equal to or more than the simple interest depending on the time and frequency of compounding.

Simple Interest vs Compound Interest Infographics

Let’s see the top differences between simple vs. compound interest.

What will be the difference between simple interest and compound interest?

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Examples of Simple Interest vs Compound Interest

Example #1

Consider a person XYZ who keeps $ 1000 in a bank for one year at a 5% interest rate. Calculate the Simple and compound interest (compounded annually).

Simple Interest = P * R * T/100

  • SI = 1000 * 5 * 1/100
  • SI = $ 50

Compound Interest = P (1 + r/100)T – P

  • CI = 1000 (1 + 5/100)1 – 1000
  • CI = $ 50

The interest is equal since the interest is compounded annually, and the deposit duration is 1.

Example #2

Let’s consider the same example and change the duration to 2 years.

Simple Interest = P * R * T/100

  • SI = 1000 * 5 * 2/100
  • SI = $ 100

Compound Interest = P (1 + r/100)T – P

  • CI = 1000 (1 + 5/100)2 – 1000
  • CI = 1102.5 – 1000 = $ 102.5

Thus, with the change in the deposit duration, the interest earned has increased by $ 2.5. This, $ 2.5, is the interest earned on the interest accumulated in the first year of the deposit.

Key Differences

Key Differences are as follows –

  • Simple interest is interest only on the principal, whereas compound interestCompound InterestCompound interest is the interest charged on the sum of the principal amount and the total interest amassed on it so far. It plays a crucial role in generating higher rewards from an investment.read more is the interest earned on the principal and the subsequent interest accumulated over the period.
  • The principal amount remains the same in simple interest, whereas the principal amount changes as the interest accumulates over time.
  • Simple interest does not depend on the frequency of the interest calculation, whereas compound interest depends on the frequency; the compound interest is higher when the frequency increases.
  • Compound interest is always higher than or equal (only if compounded annually and for a term of 1 year) to the simple interest.
  • Simple interest has lesser returns to the investor than compound interest.
  • Wealth creation is more when the principal is compounded than when simple interest is used.
  • The final amount after the period ends in a simple interest is given by P (1 + RT/100), whereas the final amount in Compound interest is P (1 + r/100)T
  • The interest earned when it is simple interest is calculated as P * R * T/100, whereas when the interest is compound, the interest earned is P ((1 + r/100)T – 1).

Simple vs Compound Interest Comparative Table

BasisSimple InterestCompound InterestDefinitionSimple Interest is earned only on the principal amount.It is on the principal as well as the interest accrued over time.Amount of interest earned.The amount of interest earned is small and leads to lesser wealth growth.The amount of interest earned is higher, and wealth growth increases as the interest are earned on the accumulated interest in the previous periods.Returns on principalFewer returns as compared to compound interestHigher returns than the simple interest due to compoundingPrincipalThe principle remains the same during the tenure.Principal increases as interest are compounded and are added to the original principal.CalculationIt is easy to calculateIt is a bit complex in calculation than simple interest.Frequency of Interest RateDoes not depend on the frequency of interest accumulationIt depends on the frequency of interest calculation, and the amount increases if the frequency increases.FormulaP * R * T/100P (1 + r/100)T – PAmount Earned After DurationP * R * T/100 + PP (1 + r/100)T

This has been a guide to Simple Interest vs. Compound Interest. Here we discuss the top difference between them, infographics, and a comparative table. You may also have a look at the following articles –

What's the difference between simple interest and compound interest?

Generally, simple interest paid or received over a certain period is a fixed percentage of the principal amount that was borrowed or lent. Compound interest accrues and is added to the accumulated interest of previous periods, so borrowers must pay interest on interest as well as principal.

What will be the difference between simple and compound interest at 10?

Answer: Principal sum = ₹1000, interest rate = 10%p.a. , time= 4yrs. Simple interest= P.R.T/100 = 1000×10×4/100 = 400. Compound interest= P{1+ R/100}™ - P =1000{1+10/1000}^4-1000 = 1464.1 - 1000 = 464.1 Thus difference in interests= 464.1 - 400 = ₹64.1.