Understanding the role of interest in investment and debt calculation is essential as it plays a direct role in deciding its outcome. In the case of investment, it will indicate the total income an individual stands to make. Whereas credit instruments, it determines the total outstanding.
Now, when it comes to calculating interest, there are two ways, simple interest, and compound interest. Therefore, it is crucial to understand these two concepts before making any financial decision to get a possible deal.
What Is Simple Interest?
Simple interest is one of the ways to compute interest over a definite period. In this interest calculation system, the principal amount does not alter with time; instead, the interest amount is added after a specified interval, separately.
- The simple interest rate formula is: SI = (PXRXT)/100
Here, P denotes principal, R represents the rate of interest, and T is for time or tenor.
Following is an example to explain this concept further –
You have invested of Rs. 6 lakh against an interest rate of 6% p.a. for three years. Thus, the total interest earned during this period will be –
- SI = (600000X6X3)/100
- SI = Rs.1,08,000
In addition to understanding the calculation method and formula, individuals should also comprehend its benefits.
Advantages Of Using The Simple Interest Method
Easy computation
Talking about the benefits of simple interest, the first point to state here is the ease of calculation. The formula of SI is straightforward, and since there is no compounding factor to take into account, one can quickly compute it.
Lower interest burden
In terms of calculating a loan burden, a simple interest method reduces the total outstanding amount. For instance, a personal loan availed at 6% SI will have a lower outstanding than 6% CI. This helps individuals to manage their credit better.
Remains constant
Another point to understand about simple interest is that the interest amount, in this case, remains constant. Since the previous year’s interest is not added to the principal amount like in the compound system, the interest amount does not change.
Here is an example to demonstrate this process further –
You have an Rs. 5 lakh loan for a tenor of four years against the interest of 7% under the simple interest calculation method.
In this case the total interest will be –
- SI = (500000X7X4)/100
- SI = Rs.1,40,000
This interest figure is for four years; thus, the yearly interest amount will be Rs. 35,000.
Moving ahead, a point to note here is that a simple interest rate is not a widely used concept in case of any financial transactions. Individuals should learn the one used for loan EMI calculation to get a clear idea.
Which interest rate system is used for EMI calculation?
The interest rate system on any financial product has a critical role in determining its return. However, none of the methods stated above is used in calculating EMIs. Instead, financiers use the reducing balance method for personal loans and other financial products.
The formula of reducing balance method is –
- EMI = [P x R x (1+R)^N]/[{(1+R)^N}-1]
Here,
- P denotes the principal amount
- R stands for interest rate
- N reflects loan tenor
Read Also: Apply for Personal Loans from Top NBFCs such as Bajaj Finserv
Interested borrowers can utilise this formula to get monthly instalments. Nonetheless, completing it manually can be a tough ask. Thus, they can use a personal loan calculator to get the needed results without any hassle. Additionally, online calculators like these provide an in-depth understanding of the payable loan balance that includes interest rate amount and a principal component.
Moreover, it is vital to understand that failing to pay EMIs can result in paying penalty charges. And it can leave a negative effect on a borrower’s credit profile. Hence, individuals should know the mistakes to avoid when it comes to repaying a debt.
Moving ahead, when applying for a loan, it is essential to review the loan terms and additional charges. These associated charges can increase the total borrowing cost. Hence, it is vital to understand how to choose a right lender to dodge the hassle of bearing any unnecessary expenditure.
Besides, intending debtors can also look for financial institutions that simplify the loan application process and save time. Individuals can, thus, resort to the pre-approved offers provided by Bajaj Finserv. These offers are available on financial products like credit cards, business loans, personal loans, etc. Prospective borrowers can check their pre-approved offers by submitting their essential contact information.
Besides understanding the related charges and how to ease the loan application process, individuals should also know about the best tips to apply for personal loans without any issues.
Simple interest and compound interest plays no part in EMI calculation. Nevertheless, having an understanding of them is crucial, as it aid individuals to get a comprehensive idea about the return that they can get from their investments.
Read Also: How to Invest in Trading Tips
