Simple Interest

Simple interest is calculated exclusively on the original principal amount of a loan or investment. Unlike compound interest, it does not factor in any previously accumulated interest. This makes it straightforward to calculate and typically less expensive for borrowers.

Simple interest is commonly used in short-term loans, auto loans, and some personal loans. It is also used in calculating interest on Treasury bonds and certain savings instruments. The calculation is linear, meaning the interest earned or owed grows at a constant rate over time.

The key difference between simple and compound interest becomes more pronounced over longer time periods. A $10,000 investment at 5% simple interest earns $500 per year regardless of time. With compound interest, it earns $500 the first year, $525 the second, $551.25 the third, and so on, accelerating growth exponentially.