What is simple interest? Distinguish simple and compound interest

Simple interest is the interest on loans calculated on the basis of the original loan. Let’s find out with Fastloans.PH what is simple interest? Distinguish simple interest and compound interest.

What is simple interest?

Simple interest is the interest on loans calculated on the basis of the original loan. This implies that interest costs increase over time in a linear fashion.

For example, if the initial loan is 100.000 PHP at an interest rate equal to 10%, then after year 1, the total interest and principal are equal to 110.000 PHP, in the second year, total interest and capital is 120.000 PHP v… v…

simple-interest

Related terms

Interest is generally the amount earned (to the lender) or spent (to the borrower).

Compound interest is the amount of interest determined on the basis of the interest amount of the previous periods and included in the principal to serve as a basis for calculating interest for the next period.

Simple interest formula

I = P x r x n

Where I is the simple interest, P is the principal, r is the one period interest, n is the number of interest periods.

The amount after n deposit terms is

Pn = P0 + P0 x i x n = P0 (1+ i x n)

For example: a person deposits 10.000 PHP into a periodical account to calculate simple interest with an interest of 8% / year.

After 10 years, the principal and interest amount earned is 10.000 + 10.000x 0.08 x10 = 18.000 PHP.

Example 1: A person deposits PHP 10.000 into a bank with 3-month deposit term, interest rate of 1% / month. How much money does that person receive when it is due?

The answer

  • Interest rate 1% / month Interest rate 1 period is 1% x 3 = 3%
  • The interest he receives is 10.000 x 1% x 3 = 300 PHP

Conclusion: So when it is due, that person will receive the amount of 10.300 PHP; in which the principal is 10.000 PHP and the interest received after 1 interest period (3 months) is 300 PHP.

Example 2: A person buys a government bond with the amount of 100.000 PHP, interest rate 10% / year, 3-year term. Determine the total amount of interest the person will receive after 3 years (know that the interest is paid out once a year).

Since bond interest is received once a year, it is calculated using the simple interest method.

The answer

Interest is received at the end of the first year

100.000 x 10% = 10.000 PHP

  • Interest received at the end of the second year

100.000 x 10% = 10.000 PHP

  • Interest is received at the end of the third year

100.000 x 10% = 10 .000 PHP

  • Conclusion: So the total interest the investor receives after three years is

10.000 + 10.000 + 10.000 = 30.000 PHP

Or can be calculated as follows 100.000 x 10% x 3 = 30.000 PHP

Distinguish simple and compound interest

The compound interest rate is often arguably one of the most powerful concepts in the world of finance. So what is compound interest and how does it differ from simple interest?

simple-interest-vs-compound-interest

Let’s say you deposit PHP 10,000 in a savings account with a simple 5% interest rate for 3 years.

The interest rate you earn each year is 5% multiplied by PHP 10,000 will equal PHP 500. Thus, the end of year 3 will reach a total of PHP 1,500 (PHP 500 + PHP 500 + PHP 500).

In case you deposit the same amount of PHP 10,000 but with 5% compounding annual interest.

  • In the first year, your profit is also 500 dollars.
  • But in second year, the profit you make is 5% of PHP 1,500 (5% of the initial PHP 10,000 plus the profit you made in the first year is PHP 500), which gives the second year PHP 525.
  • In the third year, you make 5% of PHP 11,025 [PHP 10,000 + PHP 500 (1st year profits) + PHP 525 (2nd year profits)], and your 3rd year income is PHP 551.25.

In total you make PHP 1,576.25 over 3 years compound interest, while the simple interest rate is PHP 1,500.

The strength of compounding becomes evident over a long period of time as profits become larger and larger.

Summary

If you still have any questions in the above article, please leave your feedback below. Fastloans.PH team will actively respond to your feedback. Good luck.

Refer: Simple interest from Wikipedia

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