Is better simple or compound interest rate ? What's the difference ?

What is the difference between simple interest and compound interest ? Which one is better ? Could you provide some examples ?
25 Apr 2021 at 03:41 PM
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florisfloris
Both simple or compound interest can be better, but in different situations. Important thing is your position, for example if you are lender, borrower, investor etc. So the key difference is whether you receive or pay the money.

You can receive / earn more, when using a compounded interest rate. Compound interest is also referred as interest-on-interest.

For example, when you invest 1000 USD for 3 years, with interest rate 5% per annum and compounding frequency 1 per year, the differences are:


Formula for Simple interest calculation:

Interest = ( B x R x T ) / 100

B = Initial principal balance
R = Annual interest rate
T = Time in years

You have to calculate the numbers in brackets first, then divide the result by 100:

Interest = ( 1000 x 5 x 3 ) / 100 = 150 USD


Formula for Compound interest calculation:

Interest = ( B x ( 1 + ( R / N ) ) ^ N x T ) - B

B = Initial principal balance
R = Annual interest rate
N = Number of times interest applied per time period
T = Number of time periods

You have to calculate the numbers in brackets step by step.

Interest = ( 1000 x ( 1 + ( 0.05 / 1 ) ) ^ 1 x 3 ) - 1000 = 157.625 USD


With simple interest you would get 150 USD and with compound interest you would get 157.625 USD.

30 Jun 2021 at 03:26 PM
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BenBen
Thank you. How should I add interest basis ACTUAL/360 or ACTUAL/365 into formula ?
28 Aug 2021 at 04:07 PM
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florisfloris
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