How Simple Interest Works
Simple interest is the most basic way to calculate the cost of borrowing money or the return on a deposit. Unlike compound interest, it’s calculated only on the original principal — the interest you earn never earns interest itself.
The formula is: I = P × r × t
- I = interest earned or owed
- P = principal (starting amount)
- r = annual interest rate (as a decimal)
- t = time in years
Simple Interest vs. Compound Interest
With simple interest, $10,000 at 5% for 10 years earns $5,000 in interest (total: $15,000). With compound interest (compounded annually), the same investment earns $6,289 (total: $16,289). The difference grows larger over longer periods.
Try our compound interest calculator to see the exponential growth effect.
| Year | Simple Interest Total | Compound Interest Total | Difference |
|---|---|---|---|
| 1 | $10,500 | $10,500 | $0 |
| 5 | $12,500 | $12,763 | $263 |
| 10 | $15,000 | $16,289 | $1,289 |
| 20 | $20,000 | $26,533 | $6,533 |
| 30 | $25,000 | $43,219 | $18,219 |
When Is Simple Interest Used?
Simple interest appears in several common financial products:
- Auto loans: Many car loans use simple interest, meaning early payments reduce total interest.
- Short-term personal loans: Payday loans and some personal loans calculate interest this way.
- Treasury bills and some bonds: Government securities often use simple interest for short durations.
- Student loans: Federal student loans accrue simple interest on the unpaid principal.
Real-World Examples
Car Loan
You borrow $25,000 for a car at 6.5% simple interest for 5 years. Interest = $25,000 × 0.065 × 5 = $8,125. Total repayment: $33,125, or about $552/month.
Short-Term Deposit
You deposit $50,000 in a 9-month CD at 4.5% simple interest. Time = 9/12 = 0.75 years. Interest = $50,000 × 0.045 × 0.75 = $1,687.50.