Where do these numbers come from?
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Simple interest does not compound: I = P × r × t.
The formula, with an example
Interest I = P × r × t, where P is the principal, r the annual rate as a decimal and t the time in years. $5,000 at 5% for 3 years earns $5,000 × 0.05 × 3 = $750, for a total of $5,750. For a period in days, use t = days ÷ 365 (some lenders use 360; the loan agreement says which).
Simple vs compound interest
| Years | Simple interest | Compound (annual) | Difference |
|---|---|---|---|
| 1 | $250.00 | $250.00 | $0.00 |
| 3 | $750.00 | $788.13 | $38.13 |
| 5 | $1,250.00 | $1,381.41 | $131.41 |
| 10 | $2,500.00 | $3,144.47 | $644.47 |
| 20 | $5,000.00 | $8,266.49 | $3,266.49 |
$5,000 at 5% a year.
Over a year or two the difference is small; over decades compounding dominates. That is why simple interest is mostly found on short-term arrangements.
Where you meet simple interest
- Many auto and personal loans charge interest daily on the outstanding balance, so paying early reduces total interest.
- Some bonds and certificates pay a fixed coupon that is not reinvested.
- Informal loans between family or friends are often agreed at a simple rate.
For savings or investments that reinvest earnings, use the compound interest calculator instead.
The formula
Simple interest = principal × annual rate × years (I = P × r × t). $10,000 at 5% for 3 years earns $1,500 and is worth $11,500. Interest never earns interest, unlike compound interest.
Where it is used
Many auto loans accrue simple interest daily on the outstanding balance, US Treasury bills and some short-term loans use it, and it is a quick way to estimate interest over less than a year. For savings and investments, use the compound interest calculator.
Frequently asked questions
Simple vs compound?
Compound interest earns interest on interest.
How do I find the rate from the interest?
r = I ÷ (P × t). $750 ÷ ($5,000 × 3) = 5%.
Is simple interest better for borrowers?
For the same stated rate, yes: you never pay interest on interest.
How do I work out interest for months?
Use years as a fraction: 6 months is 0.5 years.