What is simple interest
With simple interest, the interest is always calculated on the original principal, without compounding on interest from previous periods — unlike compound interest. It's used in some short-term loans, penalties, and as the basis for introductory financial math.
Formula
I = P × r × t, where P is the principal, r is the interest rate (as a decimal, i.e. the percentage divided by 100) and t is the number of periods. The final amount is A = P + I.
Example
A principal of $1,000 at a 2% monthly rate for 6 months: I = 1000 × 0.02 × 6 = $120. Final amount: $1,120.
Simple vs. compound interest
With simple interest, growth is linear (the same interest amount every period). With compound interest, growth is exponential, because interest from one period starts earning interest in the following periods — so over the long run compound interest always yields (or costs) more.
Frequently asked questions
What is the difference between simple and compound interest?
With simple interest, interest is calculated only on the original principal. With compound interest, interest from one period is added to the base for the next period, creating "interest on interest".
Do the rate and time need to use the same unit?
Yes. If the rate is monthly, time should be entered in months; if the rate is annual, time should be in years.
Where is simple interest used in practice?
In some fees and penalties, certain short-term instruments, and as a teaching tool for financial math — most everyday financial products (loans, savings, credit cards) use compound interest.