
Interest comes in different forms, so it’s important for borrowers and lenders to understand how it is calculated for the particular loan or investment product they choose.
As its name suggests, simple interest is a straightforward way of calculating interest where charges are only levied or paid out on the principal amount (what you borrowed or deposited). Compared to compound interest — which is charged on the principal and interest accrued — simple interest is much easier to calculate.
Read on to learn more about how it works and the types of financial products that typically use simple interest.
Simple Interest at a Glance
- Simple interest occurs only on a financial product’s principal.
- Simple interest is often a good deal when borrowing money, as you’re only paying on the principal. It’s less ideal for banking or investment accounts as it leads to lower yields given you don’t earn money on accrued interest.
- Investment products that typically use simple interest include treasury bills and bonds, while loan products using simple interest include mortgages and auto loans.
What Is Simple Interest?
“Simple interest is a straightforward fixed rate charged or earned on a principal amount over a certain period,” says Ohan Kayikchyan, certified financial planner (CFP) and founder of Ohan the Money Doctor. “Unlike compound interest, it does not account for the effect of compounding, making it a simpler concept to grasp.”
Simple interest is easy to calculate, as the amount you owe doesn’t change. You pay a fixed percentage of interest on the amount you borrowed that does not go up as interest accrues.
What Is the Formula for Simple Interest?
To calculate simple interest, you’ll need to know your annual interest rate, the term of the loan, and the amount you borrowed. The formula for calculating your interest is as follows:
Principal loan amount x annual interest rate x loan term, in years = Simple interest

Calculating Simple Interest: Examples
Calculating simple interest is easy using the above formula, regardless of the type of financial product it is applied to. For instance, if you are investing money in an account with simple interest for three years at 5%, you could determine how much you’d earn as described below:
“Suppose you invest $1,000 at an annual interest rate of 5% for five years. In this case, the simple interest earned over five years is $250, as 5% of $1,000 is $50; over five years, it totals $250,” Kayikchyan explains.
You can apply the same formula to a borrowed amount, say, on a personal loan.
You borrow $2,000 at a 7% interest rate for five years. The principal amount ($2,000), multiplied by the interest rate (0.07) and loan term (five), comes out to $700 in simple interest. That means the total amount you repay will be $2,700.
That amounts to $2,000 in principal and $700 in interest.
Types of Financial Products that Use Simple Interest
Because simple interest only yields returns on the principal amount, it often results in lower payouts than compound interest, Kayikchyan said.
“Simple interest is most beneficial for short-term loans because it lowers overall interest charges than compound interest,” he says. “It is also ideal for fixed deposits (a type of investment where you deposit a certain amount for a fixed period and earn a predetermined interest rate) or bonds with short durations, where the goal is the predictability of returns.”
Because of this lower payout but increased predictability, simple interest is usually offered on investments like treasury bills and bonds.
Savings accounts, certificates of deposit (CDs), and other investment accounts usually offer compound interest instead to entice customers with higher returns.
You’ll most often find simple interest on loans with fixed terms, such as:
- Personal loans
- Student loans
- Mortgages
- Auto loans
Pros of Simple Interest Financial Products
- Simple interest is easy to calculate, as the amount you owe does not change.
- Predictable monthly payments can be easier to factor into your budget.
- You may be able to pay off your loan early to reduce the total amount you owe.
Cons of Simple Interest Financial Products
- Simple interest can yield lower returns on investments because you do not earn interest on the interest you accrue (known as compounding).
- Repayment terms on accounts with simple interest may be less flexible.
- You may be charged a prepayment penalty if you repay your loan early.
Bottom Line: Is Simple Interest a Good Thing?
Simple interest can be a good option when you are borrowing money, but it could lead to lower returns if you are trying to grow your money.
For example, simple interest on a loan is beneficial, as you only have to pay interest on the amount you borrowed (principal) instead of the principal and the interest that accrues on that amount.
However, on a savings account, for instance, simple interest would lead to less earned, as you only earn interest on your original deposit, not on interest accrued. In that case, you’d benefit more from a financial product offering compound interest.
Frequently Asked Questions
What Is a Simple Definition of Interest?
Interest is the charge associated with borrowing money, typically reflected as a percentage amount. Interest is also offered on top online banking and investment accounts as an incentive for keeping your money at a particular financial institution. In this case, the financial institution is paying you a certain percentage of the money in those accounts.
Interest can be simple – meaning it is charged on the principal amount borrowed or invested only – or compound – meaning it is charged on the principal amount and interest accrued. Interest also comes in both fixed and variable rates, based on whether the rate fluctuates throughout the life of the loan.
Is it Better to Earn Simple or Compound Interest on a Savings Account?
Simple interest only accrues on principal. Compound interest accrues on your principal and accumulated interest. As a result, it’s more beneficial to have a savings account that offers compounding interest, given you’ll earn money on both your deposits and your earned interest.