Simple interest is calculated from the principal, the interest rate and the period.
Simple interest is that which produces an investment over time thanks to the initial capital . Therefore, it is calculated based on the principal capital, the interest rate and the period (the time of the investment).
Before moving forward, it is important to indicate that the term interest (from the Latin interesse which translates as “to import” ) has a use in finance linked to value , utility and profit . To put it another way, it refers to the profit produced by capital , which can be known through a series of calculations and operations and represents one of the greatest elements of the economy of an organization or company .
In other words, interest is an index that, through a percentage , allows us to express the profitability of savings or the cost of a loan . A fixed term of 10,000 pesos with an annual interest of 10% implies that, after one year, the saver will receive 1,000 pesos in interest.
On the other hand, the interest on a credit is what the person requesting the loan from a financial institution must pay based on the time elapsed since the loan was acquired and taking into account the conditions agreed upon in the contract . When requesting a loan of 5,000 pesos with an interest of 20%, the subject will have to pay 1,000 pesos of interest, for which the sum of 6,000 pesos will be returned.
Calculation of simple interest
The important thing when considering simple interest is that the interest produced by the capital in a certain period is not accumulated to generate the interest corresponding to the following period.
This means that the simple interest generated by the invested capital will be the same in all periods of duration of the investment, as long as the rate and term do not vary.
Simple interest can be applied to a loan.
Differences with the compound
It is important to note that since simple interest is calculated based on the primitive capital, in each unit interval of time it remains unchanged, because said capital also does so.
This calculation can also be used to know the profits that have been obtained in a certain period of time (at the beginning) and allows access to information on what equivalent capital we may have in a defined future future. In general, the calculation of simple interest is usually used for short terms of time, less than 1 year. It is also important to note that simple interest does not capitalize.
For its part, compound interest is what allows us to know the cost of money over time, starting from an initial capital. In this way, the fluctuation of profits, investments and losses that have occurred between different time periods can be known. This is calculated taking into account the initial capital and the specific investments of each period, and here comes the point where it differs absolutely from simple interest : the profits in the compound are capitalized and reinvested or added to the initial capital.
It should be noted that saying that simple interest does not capitalize is not entirely true, it is just that it does so only once , at the beginning of the activity, while compound interest does so as many times as the operation is carried out.
An example to understand them better : if we have a value of 100 amount with interest rates of 10% and we only capitalize once, we will obtain 101 at the end (the simple interest will be equal to the amount plus the interest rate); If, on the other hand, we capitalize four times, the result will be greater (the compound interest will be 104.06 at the end because it is calculated based on the number of capitalizations that are made).