Know the differences between compound interest and simple interest formula. Several factors contribute to the overall cost of a loan that an individual repays. Interest levy is one of the foremost factors influencing this cost and an individual’s borrowing decision. While several aspects impact the final interest levy, most are based on the individual’s financial profile.
In all this, individuals often miss out on the calculation method of interest cost that contributes to the total loan liability they need to pay by the tenor’s end. When computing the price, it is the choice and use between compound interest and simple interest formula.
Compound and simple interest – Meaning and scope
Both simple and compound interests are methods of interest computation for a given amount at a specified rate. Before going into the compound interest and simple interest formula, let’s first understand what interest means and what the two methods comprise. It can be simply defined as the cost an individual needs to bear when borrowing an amount in the financial market. It is payable periodically as agreed by the lender. However, such accumulated payment must be completed by the tenor’s end. Usually, a borrower needs to pay interest as a component of EMIs until full repayment or the tenor’s end, whichever is earlier.
- Simple interest
Simple interest is a calculation method that computes the total interest payable based on the borrower’s fixed principal value. During the tenor, any such cost accruing is considered a separate liability and not combined with the principal.
- Compound interest
Compound interest is a method of calculation that uses variable principal for the computation. Under this method, analysis occurs periodically and not at a time. The interest computed for a particular duration is added to the principal for interest computation of the following term.
For instance, if P is the principal amount borrowed and R is the interest computed for a month, interest computation for the next month will be made on (P+R) instead of P.
Usually, when interest computation for loans and advances is undertaken, the compound interest method is used for such calculations. So, even though it is not a factor that may affect your personal loan interest rates, it definitely impacts the total interest payable.
Nevertheless, you can attempt to reduce your total loan liability under certain circumstances with a few things in place. For instance, if you are availing of an instant personal loan, applying with a high credit score improves the chances of interest rate reduction overall.
You can take several steps to improve your personal credit score and benefit when availing of a loan. When getting a personal loan with a poor credit score or a personal loan without CIBIL, you might as well prepare to pay interest at high rates as it increases the lender’s risk. Getting an instant loan for a low CIBIL score should not be a challenge as long as you meet other eligibility requirements and agree to lender terms.
Lenders like Bajaj Finserv further offer attractive rates on different types of short-term loans in India as collateral-free financing with a minimum credit score of 750. The Bajaj Finserv EMI overdue charges are also nominal, making loan servicing affordable if EMI payment is delayed. You may access the Bajaj Finserv helpline number to learn more about the applicable fees and charges.
They also bring pre-approved offers to make financing hassle-free and quick for individuals. The offers are available on personal loans, business loans, credit cards, and other financial products. You can provide your name and contact details to check your pre-approved offer.
Compound interest and simple interest formula
Check out the compound interest and simple interest formula to better understand the calculation differences:
Simple interest = (Principal x rate x time)/100
Compound interest = Principal + [(1 + Rate/n) time x n – 1]
Here, n refers to the number of times interest is compounded in a year.
However, financial institutions use more complex formulas for interest calculation, as the above represents interest calculation of one year only.
Points of difference between simple and compound interest
- The interest value under simple interest is less, while that under compound interest is much higher.
- The principal does not change under simple interest computation. Under compound interest, a new principal is considered after adding previous interest every time.
- Interest charge under the simple interest method is on the principal amount only. For compound interest, it is charged on both the principal and interest values accrued.
- Liability accumulation under simple interest is slow. It is rapid under compound interest calculation.
Along with this understanding of compound interest and simple interest formulas and differences, it is best to know more about fixed and floating rate systems as well. It should help you gain a wider perspective on how interest is computed and added to your loan principal for repayment.