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.
Key Insights
- Simple interest is calculated only on the principal amount.
- It benefits borrowers more than investors, due to lower total repayment costs.
- Common uses: auto loans, personal loans, and short-term bonds.
- Unlike compound interest, it does not accrue on previously earned interest.
- The formula is: Principal × Interest Rate × Time = 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 one of the most basic methods for calculating interest, as it applies only to the original amount borrowed or invested, also known as the principal. Unlike compound interest, it does not accumulate interest on previous interest charges.
Expert Quote
Simple interest is a straightforward fixed rate charged or earned on a principal amount over a certain period. Unlike compound interest, it does not account for the effect of compounding, making it a simpler concept to grasp.
Ohan Kayikchyan certified financial planner (CFP) and founder of Ohan the Money Doctor
Simple interest is also easy to calculate. Because the interest applies only to the principal balance, the amount you owe (or earn) stays predictable over time, making budgeting and payoff planning simpler.
How to Calculate 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
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.
Where Is Simple Interest Used?
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 and Cons of Simple Interest Financial Products
| Pros | Cons |
| ✅ Easy to calculate the interest, stays fixed over time | ❌ Lower returns on savings/investments (no interest on accrued interest) |
| ✅ Predictable monthly payments, easier for budgeting | ❌ Less flexibility in repayment terms for some loans |
| ✅ You may save money by repaying early | ❌ May include prepayment penalties depending on the lender |
| ✅ Often used in short-term loans or fixed-term investments | ❌ Not ideal for growing savings over time |
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 only on the principal amount borrowed or invested, or compound, meaning it is charged on both the principal amount and the interest accrued. Interest also comes in both fixed and variable rates, based on whether the rate fluctuates throughout the life of the loan.
Is Simple Interest Good or Bad?
It depends. It's great for borrowers due to predictable costs, but less attractive for investors seeking compounded returns.
What’s the Difference Between Simple and Compound Interest?
Simple interest applies only to the principal, while compound interest includes interest on interest.
When Should You Choose a Loan with Simple Interest?
When you want predictable payments and lower total interest, especially for short-term borrowing.
Does Simple Interest Affect Your Monthly Payment?
Yes. Your payment is typically fixed and predictable, unlike variable payments under some compound interest loans.
