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Simple Interest
What is Simple Interest?
Simple interest is a straightforward method of calculating the interest charge on a loan or principal amount. It is calculated only on the original principal and does not include interest on the interest (compounding). This makes it easier to calculate but generally results in lower returns compared to compound interest.
Key Factors of Simple Interest
The calculation for simple interest is influenced by three main factors:
- Principal Amount: The initial amount of money you invest or borrow.
- Interest Rate: The rate at which your investment grows, expressed per time period (e.g., annually or monthly).
- Time Period: The duration (in years or months) for which the money is invested or borrowed.
Taxation on Interest Income
The interest earned from investments is generally taxable. It is added to your total income for the financial year and taxed according to your applicable income tax slab. Financial institutions may deduct Tax at Source (TDS) if your interest income exceeds a certain threshold.
Simple vs. Compound Interest
- Simple Interest: Calculated only on the initial principal amount. Your interest earnings do not earn interest themselves.
- Compound Interest: Calculated on the principal amount *and* on the accumulated interest from previous periods (interest on interest). This leads to much faster, exponential growth over time.
Understanding the Simple Interest Formula
The total interest and final value are calculated using two simple formulas. The formula $I = P \times r \times t$ requires the rate (r) and time (t) to be in the same units.
- A = Maturity Amount (Future Value)
- I = Total Simple Interest
- P = Principal Amount (Initial Investment)
- r = Annual Rate of Interest (in decimal)
- t = Tenure in Years