Simple Interest Rate Formula (Table of Contents)
- Simple Interest Rate Formula
- Examples of Simple Interest Rate Formula (With Excel Template)
- Simple Interest Rate Calculator
Simple Interest Rate Formula
In general parlance, Interest refers to the additional amount paid for obtaining monetary assistance from the lender. In finance terms, when we borrow some amount from any bank or financial institution, we have to repay that amount along with some additional amount for availing of that facility. Such extra amount paid is termed as Interest.
Interest can be of different types like Simple Interest, Compound Interest, Effective Interest, Annual Yield etc. In this article, we will discuss Simple Interest.
Simple Interest Formula is one of the easiest ways of calculating interest on Short term Loans and Advances and Term Loans. In the case of Simple Interest, Interest is calculated on the Loan amount, which is also termed as Principal Amount of loan. In this case, Interest is not calculated on Interest Amount accruing on the loan amount, likewise in the case of the Compound Interest Formula.
To calculate Simple Interest, we need the Amount Borrowed along with the period for which it has been borrowed and the Rate of Interest.
The formula for Simple Interest is:
This formula is also abbreviated as:
- I = Interest Amount
- P = Loan Amount or Amount Borrowed
- R = Rate of Simple Interest
- T = Tenure of Loan or Time Horizon
Examples of Simple Interest Rate Formula (With Excel Template)
Let us understand this formula with the help of some examples.
Simple Interest Rate Formula – Example #1
Ram took a loan from his banker of Rs.100000 for a period of 5 years. The rate of interest was 5% per annum. Calculate the interest amount and his total obligation at the end of year 5.
So, Interest Amount using simple interest rate formula will be:
- I = P * R * T
- I = 100000 *5% *5
- I = Rs.25000
Interest Amount is Rs. 25000
Total Obligation is calculated as
- Total Obligation (Repayment Amount) = Principal + Interest
- Repayment Amount = 100000 + 25000
- Repayment Amount = Rs. 125000
Simple Interest Rate Formula – Example #2
Ram purchased a Mobile of Rs.20000 from an outlet at a loan. The terms of the loan are as follows:
Calculate the EMI and Interest amount per period.
- P = 20000
- R = 12%p.a.
- Time = 1Year
- No. of periods for payment (N) = 12 monthly
So, EMI and Interest amount can be calculated in Excel using PMT Function. Alternatively, we can also calculate the EMI and Interest using the formula,
- EMI = [P * R * (1+R)^N]/[(1+R)^N-1]
- EMI = [20000*12%*(1+12%)^12]/[(1+12%)^12-1]
- EMI = Rs. 1776.98
By using the formula, we come to know that Ram has to pay an EMI of Rs.1776.98 for 12 months. His Interest payment for each period will reduce and correspondingly principal repayment will increase gradually, resulting in full payment of loan amount, along with interest at the end of 12 months.
The calculation of EMI, Principal repayment and Interest involved in each EMI is shown in the below figure:
As we can see that EMI will remain the same and with each repayment of monthly installment, Outstanding Loan Amount will also reduce and will become zero at the end of loan term.
Simple Interest Rate Formula – Example #3
DHFL Ltd issued a coupon-bearing bond of Rs.100000 which carries an interest rate of 7% p.a. the bond has a useful life of 15 months, after which the bond will be redeemed.
Interest earned by the investor can be calculated as follows:
For calculating interest, we need to bring interest rate and time period in symmetry. So,
The time period is calculated as:
- Time period = 15 /12 years
- Time period =1.25 years
Interest Amount using simple interest rate formula will be:
- I = P * R * T
- I = 100000 * 7% * 1.25
- I = Rs.8750
So, the interest earned by an investor on the redeemable bond is Rs.8750.
Interest Rate Formula is helpful in knowing the Interest obligation of the borrower for the loan undertaken and it also helps the lender like financial institutions and banks to calculate the net interest income earned for the assistance given.
While calculating simple interest, one thing to remember is that Rate of Interest and Time Period of loan should be in symmetry i.e. If the rate of interest is per annum then a number of periods must also be expressed in yearly terms. Conversely, if the Time period is monthly/quarterly, the Interest rate should also be converted according to monthly/quarterly frequency.
In this formula, the Interest amount is higher in the Initial period of Loan and it gradually decreases over the remaining life of the loan.
Significance and Use of Simple Interest Rate Formula
- This formula is one of the simplest formula for calculating Interest Obligation and it does not take into account the features of the compound interest formula i.e. Interest on interest.
- This formula is used in case of Short Term Loans & Advances and Borrowings.
- This formula is also used by Banking Industries for calculating interest on Saving Bank accounts and Short Term Deposits.
- Interest on Car Loans and Other Consumer Loans is also calculated through Simple Interest Rate Formula.
- Certificate of Deposits (CD) is also embedded with the Simple Interest Rate feature.
- Bonds also pay simple interest in the form of coupon payments.
Simple Interest Rate Calculator
You can use the following Simple Interest Rate Calculator
|Simple Interest Rate Formula =||Principal Amount x Rate of Interest x Time Period|
|=||0 x 0 x 0 = 0|
This has been a guide to the Simple Interest Rate formula. Here we discuss its uses along with practical examples. We also provide you a Simple Interest Rate Calculator with a downloadable excel template. You may also look at the following articles to learn more –