Q1: What is simple interest and how is it calculated?
Simple interest is interest calculated only on the principal amount, not on previously earned interest. The formula is: Interest = Principal × Rate × Time. It's straightforward and linear, making it easy to calculate and understand.
Q2: What is the difference between simple interest and compound interest?
Simple interest is calculated only on the original principal amount, while compound interest is calculated on the principal plus accumulated interest. Over time, compound interest yields significantly higher returns, but simple interest is easier to calculate and predict.
Q3: When is simple interest typically used?
Simple interest is commonly used for short-term loans, car loans, personal loans, and some savings accounts. It's preferred when you want predictable, linear interest calculations without the complexity of compounding.
Q4: How do I calculate simple interest manually?
Multiply the principal amount by the annual interest rate (as a decimal) and then multiply by the time period in years. For example, $10,000 at 5% for 3 years = $10,000 × 0.05 × 3 = $1,500 in interest.
Q5: Is simple interest better than compound interest for borrowers?
Yes, simple interest is generally better for borrowers because the total interest paid is lower and more predictable. However, most loans use compound interest, so it's important to understand both types when making financial decisions.
Q6: Can simple interest be used for investments?
While simple interest can be used for investments, it's less common because compound interest provides better returns over time. Most investment products like savings accounts, bonds, and certificates of deposit use compound interest to maximize returns.