![]() Simple Interest Versus Compound InterestĬompound interest is another method of assessing interest. To take advantage of compounding you would need to reinvest the dividends as added principal.īy contrast, most checking and savings accounts, as well as credit cards, operate using compound interest. Investments may also offer a simple interest return as a dividend. However, some assets use simple interest for simplicity - for example bonds that pay an interest coupon. Investing in assets that don't offer compound growth means you may miss out on potential growth. You may see simple interest on short-term loans.įor this same reason, simple interest does not work in your favor as a lender or investor. That contrasts with compound interest, where you also pay interest on any accumulated interest. Simple interest works in your favor as a borrower, since you're only paying interest on the original balance. What Financial Instruments Use Simple Interest? ![]() If you had a monthly rate of 5% and you'd like to calculate the interest for one year, your total interest would be $10,000 × 0.05 × 12 = $6,000. ($10,000 + $2,500 = $12,500.) You can also divide the value to determine how much interest you'd pay daily or monthly.Īlternatively, you can use the simple interest formula I=Prn if you have the interest rate per month. Now that you know your total interest, you can use this value to determine your total loan repayment required. Then, you'd multiply this value by the number of years on the loan, or $500 × 5 = $2,500. To start, you'd multiply your principal by your annual interest rate, or $10,000 × 0.05 = $500. You want to know your total interest payment for the entire loan. ![]() Let's review a quick example of both I=Prt and I=Prn.įor example, let's say you take out a $10,000 loan at 5% annual simple interest to repay over five years. For instance, if you wanted to calculate monthly interest taken on a monthly basis, then you would input the monthly interest rate as "r" and multiply by the "n" number of periods. Under this formula, you can calculate simple interest taken over different frequencies, like daily or monthly. Simple Interest for Different Frequencies For instance, if you wanted to calculate interest over six months, your "t" value would equal 0.5. Under this formula, you can manipulate "t" to calculate interest according to the actual period.
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