Simple Interest Vs Compound Interest
Interest is the cost of borrowing money, where the borrower pays a fee to the lender for the loan. The interest, expressed as a percentage, can be either simple or compounded.
Simple interest is based on the principal amount of a deposit or loan.
On the other hand, compound interest is based on the principal amount and the interest that accumulates on it in every period. Simple interest is calculated only on the principal amount of a deposit or loan, so it is easier to determine than compound interest.
Key Points
- Interest is the cost of borrowing money, where the borrower pays the lender a fee for the loan.
- Simple interest received or paid 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 will pay interest on interest as well as on the principal.
Calculating Compounding Interest and Simple Interest
Simple Interest
Simple interest is calculated using the following formula:
SI = P × r × n
where:
P = Principal amount
r = Annual interest rate
n = Term of loan, in years
“Simple interest received or paid over a certain period is a fixed percentage of the principal amount that was borrowed or lent.”
Compound Interest
Compound interest accrues and is added to the accumulated interest of previous periods; it includes interest on interest and principal.
The formula for compound interest is:
CI = P × (1+r)ⁿ − P
where:
P = Principal amount
r = Annual interest rate
n = Number of years interest is applied
Compound interest is calculated by multiplying the principal amount by one plus the annual interest rate raised to the number of compound periods, and then minus the reduction in the principal for that year.
“With compound interest, borrowers must pay interest on the interest as well as the principal.”
- Need financial advice? Talk to an expert.
- Learn more about compounding.
One comment
Rose Kahiu
2022-06-10 at 8:49 AM
Am looking for a medical cover of not more than kshs 150000 per annum to cover a member plus 3 of age group 51-60.