Simple Interest Explained
Simple interest is calculated only on the original principal. The formula is SI = P × r × t, where P is the principal, r the annual rate, and t the number of years.
A ₹1,00,000 loan at 10% simple interest for 5 years earns 1,00,000 × 0.10 × 5 = ₹50,000 in interest. The interest never grows because it is always calculated on the same principal.
Compound Interest Explained
Compound interest is calculated on the principal plus all previously earned interest. Each period, the interest is added to the balance, and the next period's interest is calculated on the larger amount.
The same ₹1,00,000 at 10% compounded annually for 5 years grows to about ₹1,61,051 — earning ₹61,051 in interest, over ₹11,000 more than simple interest.
Where Each is Used
Simple interest is used for short-term loans, some car loans, and savings schemes like post office savings accounts. Compound interest applies to FDs, RDs, PPF, EPF, mutual funds, and almost all long-term investments.
Borrowers should watch out for simple-interest loans with long tenures — the interest can still be substantial. Investors should always prefer compounding instruments for long-term goals.
The Gap Grows with Time
The difference between simple and compound interest widens dramatically with time. Over 20 years at 10%, ₹1,00,000 earns ₹2,00,000 simple interest but about ₹5,72,750 compound interest.
Use our Compound Interest calculator and Simple Interest calculator side by side to see how the gap grows for your own numbers.