What is The Difference Between Simple Interest and Compound Interest? Can You Give 3 Examples of Where Each One Would be Used?

For someone unfamiliar with the fundamental differences between simple interest and compound interest, simple interest

can seem confusing. It would be helpful if we could understand them. In simple interest, only the initial principal amount is

calculated each time over the entire period. 

The calculation of compound interest involves adding the principal amount to the previous interest every time. In this

case, simple interest will accumulate at a rate of 10% per year for five years on a principal of Rs. 100, resulting in a total of

Rs. 150 after five years.





The cumulative amount after five years, if compounded at the same rate, will be around Rs. 165. This is because, after the 1st year, the interest will be calculated at Rs. 10. On the other hand, after the 2nd year, the interest will be calculated at Rs. 110 instead of Rs. 100. In other words, even if the principal amount and rate of interest remain the same, the amount will be higher after 5 years if compounded.


Simple and Compound Interest Formulas:

Simple Interest= PxRxT

Compound Interest=P (1+ r/n)^(nt)


P: Principal amount 

T: Time period

R: Interest rate 

Interest earned is of two kinds: simple interest and compound interest. In simple interest, you calculate the interest earned on the original principal and compound interest is calculated on both the original principal and interest accumulated over time.

Simple Interest can be Used in the Following Situations:

  • An interest rate and the repayment period that is fixed for personal loans

  • Loans for cars with fixed repayment terms and interest rates

  • Investing with a guaranteed return for a short period of time


Compound Interest is Used in the Following Situations:


  • The interest on savings accounts is compounded periodically (e.g. annually, monthly, etc.).

  • An interest-bearing certificate of deposit (CD) with a fixed term

  • Mutual funds or bonds that pay interest are reinvested to generate additional returns.

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