Simple interest is the most straightforward way to calculate the cost of borrowing or the return on lending money. Unlike compound interest, it does not grow on accumulated interest — only on the original principal.
The Simple Interest Formula
I = P × r × t
Where:
- I = Interest earned or owed
- P = Principal (the initial amount)
- r = Annual interest rate (as a decimal)
- t = Time (in years)
Total amount at the end: A = P + I = P(1 + rt)
Worked Example
You invest £5,000 at 4% simple interest for 3 years.
I = 5,000 × 0.04 × 3 = £600
A = 5,000 + 600 = £5,600
Simple Interest vs Compound Interest
| Feature | Simple Interest | Compound Interest |
|---|---|---|
| Interest calculated on | Principal only | Principal + accumulated interest |
| Growth over time | Linear | Exponential |
| Common use | Short-term loans, bonds | Savings, mortgages, investments |
| Formula | I = Prt | A = P(1 + r/n)^(nt) |
For short periods (under a year), the difference is negligible. Over decades, compound interest dramatically outperforms.
When Is Simple Interest Used?
Simple interest applies to:
- Car loans — most auto loans use simple interest
- Short-term personal loans
- Treasury bills and bonds (interest payments only, not reinvested)
- Store credit in some jurisdictions
Monthly Simple Interest
For a monthly rate, convert the annual rate first:
Monthly rate = Annual rate ÷ 12
I = P × (r/12) × months
Example: £2,000 at 6% annual for 8 months:
I = 2,000 × (0.06/12) × 8 = 2,000 × 0.005 × 8 = £80
Quick Reference Table
| Principal | Rate | Time | Interest |
|---|---|---|---|
| £1,000 | 3% | 1 yr | £30 |
| £1,000 | 5% | 2 yrs | £100 |
| £5,000 | 4% | 3 yrs | £600 |
| £10,000 | 6% | 5 yrs | £3,000 |
Practical Tips
Working backwards — if you know the interest paid, find the rate:
r = I / (P × t)
Checking a loan — lenders sometimes quote interest using different bases. Always confirm whether interest is simple or compound before signing.