Simple Interest And Compound Interest

July 3, 2020

You have studied this in your school, but we will see it again how it is put to use in our adult life. Yes, in school why would you care about % of interest. It all comes to play when you are an adult, working, paying your loan, and investing. I bet many of us would have forgotten what is the application of Simple interest (S.I) and compound interest (C.I)

So lets gets back to the class!!!

The term interest comes into picture when you borrow or when you invest your money, all your investments and loans are calculated on this major factor. Be it the rate of returns or the rate of interest we pay for loans. Interest is calculated by the following ways

Simple Interest ( S.I)
Compound Interest (C.I)

What is a simple interest and where it is used ?

In this system, you calculate your interest only on your principal amount ( basic amount)

P x i x n / 100

P – Principle

i – Rate of interest (%)

n – Term of the loan

The discounts you get on your E-Commerce websites and cashback offers from your bank are based on this system.

For Example,

If you get 5% cash back on your purchase of 10,000

S.I = 10000 (P) x 5(i) x 1 (n) /100

= 500

So you get a cashback of Rs 500.

What is compound interest and where it is used ?

In compound interest, you calculate interest for the principal amount plus the interest accumulated over the period. So it is like you calculate interest on interest.

A = P ( 1+ r / n )^{n t}

A – Final Amount

P – Initial Principal

r – rate of interest /100 ( to convert to decimal)

n – Time your compound per year ( if it is monthly it is 12, quarterly take 4 , and for yearly 1)

t – number of years interest is applied

However, savings banks, fixed deposits, and recurring deposits use this system to calculate the final disbursement amount. That is how the power of compounding will help you to create wealth over time.

Your credit card uses this system to calculate the final amount if you keep paying only the minimum amount.

For example ,

Your credit card bill is Rs 5000 and you pay only a minimum amount of Rs 2000. Your next bill will be with Rs 3000 + interest.

And if you dint pay the current bill your new bill will be calculated ( 3000 + Interest) + Interest.

So interest on interest will keep your loan amount to grow, this is how a small loan will grow big and eat you.

Compound interest plays a major role in your investment and in your debts, and it is important to know how it works for you and against you.