Banking

What is Simple Interest?

Simple interest is calculated only on the original amount you deposited or borrowed, not on accumulated interest. It does not account for interest earned or charged in previous periods (compounding). The formula for simple interest is Principal multiplied by the Interest Rate multiplied by Time. While less common in savings accounts, simple interest is frequently used in short-term loans and certain consumer auto loans.

For borrowers, simple interest loans are cheaper than compounding loans because the interest charge does not grow exponentially. Making extra payments on a simple interest loan directly reduces the principal balance, immediately lowering the interest calculated in subsequent periods.

Quick Facts

Calculation FormulaInterest = Principal × Annual Rate × Time (years)

Compounding FactorZero compounding; interest never earns interest

Common Loan UsageAuto loans, short-term personal loans

Payoff ImpactExtra payments reduce principal and future interest immediately

PRACTICAL EXAMPLE

A borrower takes out a simple interest auto loan of $20,000 at a 6.0% annual interest rate for 3 years. The total simple interest charge is $3,600 ($20,000 × 0.06 × 3). If the loan compounded daily, the interest charge would be higher.

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Learn More Key Concepts

Compound Interest (Banking)Interest calculated on both the initial principal and the accumulated interest from previous periods in a deposit account.

Checking AccountA highly liquid transactional deposit account held at a bank, allowing for frequent deposits and immediate withdrawals.

CD (Certificate of Deposit)A time deposit product offering a fixed interest rate for a specific term, subject to penalties for early withdrawal.

Savings AccountAn interest-bearing deposit account held at a financial institution, designed for accumulating funds with high liquidity.

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