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Difference of Compound Interest and Simple Interest | Examples, Problems

Difference between Simple Interest and Compound Interest

Mostly people get confused while distinguishing between Simple Interest and Compound Interest. These two terms are linked with each other but are completely dissimilar. So to make this concept clear, here’s the Difference between Simple Interest and Compound Interest. We have explained these two terms with brief problem solving examples so take a look.

Let’s begin with a simple definition of interest. Interest is the percentage of amount charged on the borrowed money by bank or other financial institution till the principal amount is not returned completely. The rate of interest is mutually decided by both the lender and the borrower. Interest can be charged by the bank or other financial institution in two ways that is, simple interest and compound interest.

Difference between Simple and Compound Interest

Simple interest is the percentage of interest charged on the loaned amount. On the other hand, the compound interest is that percentage of interest which is calculated on the amount lent plus accumulated interest.

In simple sense, simple interest is the sum paid by the borrower for using the principal amount for a fixed period of time. However, if the borrower failed to pay the interest and it become due for payment, it is added to the borrowed money, on this compound amount interest will be calculated for the succeeding period and this type of interest is known as compound interest.

Difference between Simple Interest and Compound Interest with Formula

Basis For Comparison Simple Interest Compound Interest
Definition

It is an interest calculated as a percentage of the borrowed money.

It is an interest calculated as a percentage of borrowed money and accrued interest.
Principal Amount Constant Goes on changing during the entire borrowing period
Return Less High in comparison to simple interest.
Growth Remains uniform Increases rapidly
Formula Simple Interest = P*r*n Compound Interest = P*(1 + r)^nk
Interest Charged on Principal amount or borrowed amount

Principal + Accumulated Interest

Get here Topic Wise Questions: Maths Formulas PDF 

Explanation of Simple Interest with an Example

Interest on car loan is the most common example of this type of interest. On car loan, interest has to be paid by the borrower only on the principal or borrowed amount. Here’s the formula used to calculate Simple interest:

Formula:

Simple Interest = P×i×n

Where P = Principal Amount

i = rate of interest

n = number of years

For Example: If an individual borrow Rs. 2000 from his friend @ 10% per annum for 4 years, then he have to return Rs.2800 to his friend at the end of 4th year Rs 2000 for Principal and Rs. 800 as interest, for keeping the amount with himself. The sum total of principal and interest is known as Amount. Also, higher the money and periods, the more will be interest.

Also Practice Here:

Explanation of Compound Interest with an Example

As described above, compound interest is calculated on the original principal amount plus accumulated interest of prior periods, as a result of this the principal amount increases and the interest for the subsequent period will vary.

Conversion Period is the time interval between two interest payment periods. At the end of the conversion period the interest is compounded as shown in the below placed table:

Conversion Period Compounded
1 day Daily
1 Week Weekly
1 Month Monthly
3 Months Quarterly
6 Months Semi-annually
12 Months Annually

To calculate this type of interest we use this formula:

Formula:

Compound Interest = P {(1 + i)n – 1}

Where, P = Principal
n = number of years
i = rate of interest per period

For Example, suppose Avi deposited a sum of Rs. 1000 to a bank at 5% interest (simple and compound) per annum for a time period of 3 years. The compound interest will be calculated as:

Solution: Here P = 1000, r = 5% and t = 3 years

Simple interest = Simple interest

Compound interest =  Compound interest

The banks usually make payment of interest on half yearly basis. On the other hand, financial institutions follow the policy of making payment of interest quarterly.

Check Out: Compound Interest Formula – Monthly/Quarterly/Half Yearly With Example

Note: This is all about difference between simple interest and compound interest. For more interesting facts, stay connected with us only at www.recruitmentinboxx.com

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