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- Simple interest is the interest applied only to the original amount of money deposited or borrowed.
- Calculating simple interest requires knowing your principal amount, annual interest rate, and time period.
- Simple interest is better than compound interest when you're borrowing money.
Simple interest is exactly what it sounds like: simple. You can use a simple interest calculator to figure out how much your money will earn if you choose to save it in accounts that typically aren't invested in the stock market, like CDs or bonds (note that high-yield savings accounts, however, tend to use compound interest).
Savings calculator
Understanding simple interest
Definition of simple interest
Simple interest is interest earned only on the initial amount invested, also known as the principal balance. Accounts with this structure earn you monthly interest in exchange for making your money available for the bank to lend out.
When borrowing money, simple interest represents the percentage of your loan balance that you owe in fees to the lender. This figure stays the same throughout the loan term.
The simple interest formula
The formula for simple interest is as follows:
Variables in a formula
To use a simple interest calculator or calculate simple interest by hand, you'll need a few pieces of information:
Your starting amount, which is how much you have in your account or will put in it once opened. This might also be called your principal balance.
The interest rate, which may also be called your rate of return. This is how much interest your principal balance will earn. Note that if your account has a variable interest rate, the interest rate can change based on the economy and actions of the Federal Reserve — so you'll want to remember that your projections are subject to change, and to re-run your calculations in the future. However, savings vehicles like CDs, which have a fixed interest rate, will not change over time.
Any regular, additional contributions you might make. Saving an extra $500, $100, or $50 a month can greatly grow your savings over time. Experts recommend setting up recurring, automatic deposits into savings through your online banking portal or app to make this easier — we tend not to miss the money we don't see. If cash is feeling tight, start with a small amount (even $10) and set a calendar reminder to revisit, and perhaps increase that contribution in six months.
A timeframe. Your earnings will increase over time, especially if you're making additional contributions. How far into the future do you want to look? You can typically calculate in months or years. Note that some savings tools, like CDs, have a prescribed timeframe you agree to up front, usually between one and five years. Because you can't withdraw your money before then without an early withdrawal penalty, you'll want to use the given timeframe in your calculations.
Before running your numbers, make sure your account uses simple interest — many accounts use compound interest instead.
Example of simple interest
The formula for simple interest requires your initial principal balance, annual interest rate, and time in years.
Say you put a sum of $800 into a savings vehicle with a 5% annual simple interest rate. You'll enter your initial sum ($800), your interest rate (5%), and the number of years (three). After three years with no additional contributions, the calculator will show that you have $926.
Applications of simple interest
Simple interest in savings accounts
A simple interest calculator becomes particularly helpful when you're making additional contributions to your savings.
For instance, take that same $800 initial sum in an account with 5% interest over three years. A simple interest calculator can help you easily run the numbers for three scenarios: contributing an extra $50, $100, or $500 a month.
Additional monthly contribution | Sum after 3 years |
| $50 | $2,867 |
| $100 | $4,805 |
| $500 | $20,306 |
Simple interest in loans
Loans that use a simple interest structure often result in lower costs for borrowers. That's because interest isn't added to the principal balance and then recalculated. Instead it's calculated upfront on the initial borrowing amount and amortized — or split into recurring payments — throughout the life of the loan.
Many mortgages, auto loans, and personal loans use simple interest.
Say you take out a $5,000 personal loan with an interest rate of 5% and a term of three years. To find out the amount of interest you'll pay, multiply the interest rate (0.5) by the term (3) by the initial amount ($5,000). Your total interest payment over the life of the loan will be $750.
Simple interest in bonds
Most bonds use simple interest, meaning the interest is not automatically reinvested. Expressed as a percentage of the face value of the bond, it is known as a coupon payment. For example, a $1,000 bond with a 6% coupon (interest rate) pays $60 per year, or $30 semiannually.
If earnings were reinvested in the bond, it would represent compound interest: You would earn 6% on $1,000, then 6% on $1,060, and so on.
Benefits of simple interest
Simple interest is easy to understand, predictable, and transparent for borrowers and investors. It's a straightforward way to calculate your earnings on a savings account or your payments on a loan.
Think about it this way: 1% in simple interest means you earn $1 for every $100 invested or saved each year. As a borrower, it means you pay $1 for every $100 you borrow.
Limitations of simple interest
Lower potential returns than compound interest
When you're looking to grow your money, simple interest might not be the way to go. An account with compound interest will accumulate money much faster.
Compound interest combines the initial amount loaned with the interest that's been accumulated from previous periods. Essentially, your interest earns interest on itself, meaning it snowballs over time. Compound interest can be incredibly useful in generating savings and building wealth, which is why it's best to take advantage of compound interest when saving and investing where possible.
Not suitable for long-term investments
Remember that accounts that earn significant compound interest are often those invested in the stock market, which means they take on risk you won't see in a bond or CD.
Experts typically recommend keeping money you'll need within the next five years in a savings account or other liquid, simple-interest bearing account, and investing money you won't need for a longer timeframe. You can get the best of both worlds — compound interest plus liquidity — in a high-yield savings account.
Simple interest FAQs
It is a calculation where the interest rate is applied to the principal balance of a loan or savings account. With a savings account, you'll grow your savings, but with a loan, you'll have to pay more than the amount borrowed.
The formula for simple interest is (principal x rate x time).
Simple interest is used often in personal loans, mortgages, and auto loans, as well as bonds.
Simple interest is easy to understand and results in predictable payments on loans.
Simple interest will provide lower returns on a growing savings account than compound interest. Therefore, it's not a suitable interest structure for long-term wealth building.
