Simple Interest

Simple interest is interest calculated only on the original principal amount of a loan or deposit, without factoring in any interest that has already accrued in earlier periods. This contrasts with compound interest, where interest earned in one period is added to the principal and itself earns interest in later periods, causing growth to accelerate over time rather than proceeding at a constant pace.

Because the base used for calculation never changes, simple interest grows in a straight line over time rather than accelerating, which makes it easier to calculate by hand and more favourable to borrowers than an equivalent compound-interest arrangement over long periods. Certain short-term loans, some bonds, and basic consumer finance products are structured using simple interest, while most mortgages, credit cards and long-term savings products use compounding instead.

With simple interest, the amount of interest you earn or owe each period is always calculated on the same starting amount, so a 100 loan at 10 percent simple annual interest owes exactly 10 in interest every single year, year after year, regardless of how many years have already passed.

The standard calculation is:

Here, $I$ is the interest earned or owed, $P$ is the principal, the original amount borrowed or deposited, $r$ is the annual interest rate expressed as a decimal, and $t$ is the length of time the money is borrowed or invested, expressed in years. For example, a loan of 5,000 at a simple annual interest rate of 6 percent held for 3 years accrues interest of 5,000 multiplied by 0.06 multiplied by 3, which equals 900, bringing the total repayment to 5,900.

Simple interest is common in short-term lending, certain promissory notes, and some auto loans, where the straightforward calculation benefits borrowers compared with compounding over the typically shorter life of these loans. Over longer periods, the gap between simple and amortising compound structures widens considerably, which is why long-term products such as mortgages and savings accounts almost always compound instead of using a simple interest basis.

Because simple interest accrues strictly in proportion to time elapsed rather than compounding, a borrower who repays a simple-interest loan early generally saves exactly the interest that would otherwise have accrued for the remaining period, with no complicated adjustment needed to work out the correct payoff amount. This straightforward relationship between time and cost is one of the practical advantages simple interest offers borrowers who expect to repay a loan ahead of schedule, compared with some compound-interest structures where early repayment savings can be harder to calculate precisely.

A small number of savings products, particularly very short-term deposits, calculate interest on a simple basis rather than compounding, meaning the stated annual rate directly describes the actual return earned without any additional boost from reinvested interest along the way. Savers comparing two products should check carefully whether an advertised rate is calculated on a simple or compound basis, since a compound rate will generally produce a meaningfully higher actual return over the same period at an identical headline percentage.

Historically, many jurisdictions' usury laws and court-awarded interest on unpaid debts were calculated on a simple basis by default, reflecting a legal tradition that treated compounding as something that had to be specifically agreed rather than assumed automatically. Some courts and statutory interest provisions still apply simple interest by default today, particularly for interest awarded on judgments or unpaid taxes, unless a contract or specific law explicitly provides for compounding instead.

Consumer advocates have noted that borrowers do not always understand whether a particular loan uses simple or compound interest, a distinction that can be easy to overlook amid other loan terms but that meaningfully affects the true cost of borrowing over time, particularly for longer-term loans. Checking explicitly whether quoted loan terms use simple or compound interest, rather than assuming one or the other, is a worthwhile step before comparing the real cost of competing loan offers.