Simple interest
Interest calculated only on the original principal, not on interest that has already built up.
What it means
With simple interest, the interest charge each period is a fixed percentage of the original principal. Interest does not earn interest, so the total grows in a straight line over time.
Many auto loans and some personal loans use a simple interest method in which interest accrues daily on the outstanding principal, so paying early or extra reduces cost. Most savings accounts and credit cards, by contrast, compound. Over long periods, compound growth outpaces simple interest by a wide margin.
Formula
I = P × r × t
- I = interest
- P = principal
- r = annual interest rate as a decimal
- t = time in years
Example
Suppose you lend $10,000 at 5% simple interest for 3 years. Interest is $10,000 × 0.05 × 3 = $1,500, so you get back $11,500. With annual compounding instead, you would get about $11,576.
How it’s used
- Calculating interest on many auto and personal loans
- Quick estimates of short-term interest
- Understanding some bonds, which pay a fixed coupon on face value
Related terms
Educational information only, not financial, tax or legal advice. Rules, limits and rates change; check the IRS, your lender or plan, or a qualified professional before acting.