Simple and Compound Interest

09 Mar Simple and Compound Interest

Interest rates are very powerful and intriguing mathematical concepts. Our banking and finance sector revolves around these interest rates.

Interest is the amount charged by the lender from the borrower on the principal loan sum. It is basically the cost of renting money. And the rate at which interest is charged on the principal sum is known as the interest rate.

When calculating interest rates, there are 2 common methods used to do so, they are simple interest and compound interest. Interest rates are normally given in per annum, meaning that in order to calculate the interest rate per month, you need to divide it by 12. In the below explanations, we will use an interest rate of 12% per annum which would be 1% per month to explain.

Simple interest is easy to understand, all calculations would only involve the amount of money that is initially put in (principal amount). It is that type of interest which once credited does not earn interest on itself. It remains fixed over time. Every month, you would get 1 percent of your principal amount. Meaning, the final amount you have will be the principal amount plus the interest rate (per month) multiplied by the number of months.

The formula to calculate Simple Interest is
SI = {(P x R x T)/100}
Here P = Principal Sum (the original loan/deposited amount)
R = rate of interest (at which the loan is charged)
T = Time period (the duration for which money is borrowed/deposited)

Compound interest different from simple interest does not only involve your principal account, but the interest also applies to your principal amount as well as the interest you have gotten so far. To calculate the final amount, take your principal amount and multiply it by 1 plus the interest rate per month to the power of the number of months. Compound interest is basically adding the interest you gain to your principal amount each time and is not rocket science.

Suppose an amount P is deposited in an account or lent to the borrower that pays compound interest at the rate of R% per annum then after n years the deposit or loan will accumulate to:
P(1+R/100)^n

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