Difference Between Simple Interest and Compound Interest

Difference between ci and si

The main difference between simple interest and compound interest is that simple interest is based on principal amount on the other hand compound interest is based on the principal amount and the interest compounded for a cycle of the period.

Simple interest and compound interest are the two most widely used banking terminologies. Simple interest is adopted in the case of loans, installments, educational loans, home loans, Mortgages.

The compounding interest is adopted in the case of a saving account. In this article, let us discuss the difference between simple interest and compound interest in detail.

Difference Between Simple Interest and Compound Interest

Simple Interest Definition or What is Simple Interest

The simple interest can be defined as the principal amount of loan or deposit, a person makes into their bank account. We calculate simple interest by multiplying the rate of interest by the principal by the number of days that elapsed between the payments.

The Formula of Simple Interest (Simple Interest Formula) is,

Simple Interest(SI)= (P*R*T)/100

Where P is equal to the Principal, R is equal to Rate of Interest, T= Time.

The time is in years and the rate of interest is in percentage(%).

Note:

  1. Simple interest benefits consumers who pay their loans on time or early every month.
  2. We can calculate the total amount, using the following formula: Amount = Principal + Interest

Solved examples on simple interest

Ex. 1. Find the simple interest, If P = 1000 Rs, R = 5% p.c.p.a, T= 4 months.

Sol. Here P = 1000 Rs, R = 5 % per annum T = 4months = 4/12 = 1/3 years.

Simple Interest(SI)= (P*R*T)/100

S.I = (1000*5*1/3)/100

S.I = 16.66 Rs.

Ex. 2. Find the simple interest If P = 1000Rs, R = 20% p.c.p.a , T = 4 years

Sol. Here P = 1000 Rs, R = 20% per annum, T = 4 years

S.I= (1000*20*4)/100

simple interest = Rs 800.

Compound Interest Definition or What is Compounding Interest

The compounding interest is the interest on the interest that accumulates and compounds over the principal amount. In compounding interest, the interest is calculated and added to the principal amount after each cycle of the period.

The Formula of Compound Interest (Compound Interest Formula) is,

compounding Interest(CI) = Principal(1+Rate/100)t-

Principal Where P is equal to the principal, R is equal to the rate of interest, T is equal to Time(period)

The formula to calculate the amount is Amount = Principal(1+Rate/100)t

Where P Is equal to Principal, Rate is equal to the rate of interest, T is equal to the time (Period).

Solved Example of Compound Interest

Ex.1 Tapan obtained a loan of Rs 5000 against some security. If the rate of interest is 2.5% per annum compounded annually, find the amount paid by him at the end of three years.

Sol. Given that principal = Rs 5000. Rate %= 2.5% p.a Time = 3 years

compounding Interest(CI) = Principal(1+Rate/100)t-Principal

C.I = 5000(1+2.5/100)3-5000

Compound Interest = 5,384.45-5000

C.I = 384.453

What is the difference between simple and compounding interest?

ParameterSimple InterestCompound Interest
DefinitionSimple interest based on the principal amountcompounding interest is based on principal amount and interest accumulates on each cycle of the time period
FormulaS.I = (P*T*R)/100.C.I = P(1+R/100)t-P
Return AmountS.I is much lesser than compounding interest.The C.I is much higher than S.I
Principal AmountThe principal amount is constant.The principal amount keeps increasing during the cycle of the borrowing period
GrowthThe growth is constant.The growth increases rapidly
Interest ChargedThe interest is charged for the principal amount.The interest is charged for the principal amount and accumulated interest.

 

Simple and Compound Interest Questions and Answers

1. What is simple interest?                                                                                              Ans: The simple interest is charged on the principal amount.

2. What is compounding interest?                                                                                    Ans: The compounding interest is charged on the principal amount and interest charged on the previous cycle of the period.

3. In which type of interest principal amount remain constant?                                          Ans: Simple interest.

4. Which type of interest gives the better type of return?                                                Ans: compounding interest.

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