Simple interest, and where you actually meet it
Why the formula that everyone learns in school describes almost nothing you will actually borrow, and the two places where it genuinely applies.
Last reviewed · 1,240 words
In short
- Simple interest is charged only on the original principal. It never earns on itself, so the amount added each year is identical.
- Over thirty years at 10%, simple interest turns ₹1 lakh into ₹4 lakh while compound interest turns it into ₹17.45 lakh.
- It genuinely applies to car and personal loans quoted on a flat rate, to most short-term deposits, and to the interest on delayed tax payments.
- A "flat rate" loan at 8% costs roughly the same as a reducing-balance loan at 14%. The advertised numbers are not comparable.
- Anything held longer than a year is almost always compounding, whichever direction the money is flowing.
Simple interest is charged on the original principal and on nothing else.
I = P × r × t ÷ 100
The interest of the second year is calculated on the same principal as the first, so the amount added is identical every year. That is the whole idea, and it is why almost nothing in finance actually works this way.
What it costs against compounding
₹1,00,000 at 10%:
| Years | Simple | Compound | Compound advantage |
|---|---|---|---|
| 1 | ₹1,10,000 | ₹1,10,000 | ₹0 |
| 5 | ₹1,50,000 | ₹1,61,051 | ₹11,051 |
| 10 | ₹2,00,000 | ₹2,59,374 | ₹59,374 |
| 20 | ₹3,00,000 | ₹6,72,750 | ₹3,72,750 |
| 30 | ₹4,00,000 | ₹17,44,940 | ₹13,44,940 |
They are identical for one period, because there is nothing accumulated to earn on yet. After that they diverge, slowly at first and then not slowly at all.
The simple interest column is a straight line: ₹10,000 added every year, forever. The compound column is a curve. Over a single year the distinction is academic. Over a working life it is the entire difference between the two outcomes.
Where it really applies
Flat rate loans. Many car loans, two-wheeler loans and personal loans from smaller lenders are quoted on a flat rate: interest computed once on the full loan amount for the whole term, then divided across the instalments. This genuinely is simple interest — and it is the reason the quoted rate looks so attractive.
Short-term deposits. Deposits of less than a year usually pay simple interest, because there is no compounding period inside the term. A 180-day deposit at 6.5% pays exactly half of 6.5%.
Interest on delayed tax. Sections 234A, 234B and 234C of the Income Tax Act charge 1% per month, simple, on unpaid tax. The Goods and Services Tax charges 18% a year, also simple.
Some bridging and margin arrangements, where the term is short and the calculation is deliberately kept transparent.
Old-style postal and cooperative schemes, though most have moved to compounding.
The flat rate trap
This is the one place where understanding simple interest saves real money.
A lender advertises a car loan at "8% flat" for five years on ₹6,00,000. The interest is 6,00,000 × 8% × 5 = ₹2,40,000, so the total repayable is ₹8,40,000 and the monthly instalment is ₹14,000.
That sounds cheaper than a bank quoting 14% on a reducing balance. It is not. The true cost of that loan is 14.1% on a reducing balance, so the bank quoting 14% is very slightly cheaper.
The reason is that a flat rate charges interest on the full ₹6,00,000 for all five years, even though you have repaid most of it by then. In the final month you owe about ₹14,000 and are still being charged interest on ₹6,00,000.
The rough conversion is that a flat rate is worth close to 1.8 times its number as a reducing-balance rate. Over a five-year term:
| Flat rate quoted | Monthly EMI on ₹6,00,000 | True reducing-balance rate |
|---|---|---|
| 5% | ₹12,500 | 9.2% |
| 7% | ₹13,500 | 12.5% |
| 8% | ₹14,000 | 14.1% |
| 10% | ₹15,000 | 17.3% |
| 12% | ₹16,000 | 20.3% |
The multiplier falls slightly on shorter terms and rises on longer ones, because the gap depends on how much of the principal you have already repaid while still paying interest on all of it. The rule to carry is simply this: a flat rate and a reducing-balance rate are not the same measurement and cannot be compared. Ask for the reducing-balance rate, or for the annual percentage rate, which lenders in India are required to disclose.
The same trap appears in no-cost EMI offers, where the "interest" has been moved into the price, and in gold loan schemes quoting a monthly rate that looks small until multiplied by twelve and compounded.
Interest on delayed tax payments
Advance tax is due in four instalments across the year — 15% by 15 June, 45% by 15 September, 75% by 15 December and 100% by 15 March. Falling short attracts 1% per month under section 234C, computed simply on the shortfall for the months it persisted.
Because it is simple rather than compound, the penalty is predictable and linear: three months late on a ₹1,00,000 shortfall costs ₹3,000, not ₹3,030. It is also, at 12% a year, more expensive than most secured borrowing, which makes paying advance tax on time a better use of money than it looks.
Under GST, interest on delayed payment runs at 18% a year, simple, from the due date to the date of payment. On a ₹5,00,000 liability paid forty-five days late that is ₹11,096 — again linear, and again avoidable.
Simple interest on a deposit is a warning sign
Any deposit product describing simple interest over a multi-year term is offering less than it appears.
A five-year deposit at 7% simple returns ₹1,35,000 on ₹1,00,000. The same rate compounded quarterly, which is what a bank fixed deposit actually does, returns ₹1,41,478. Same rate, ₹6,478 difference, and only the compounding convention separates them.
Chit funds, some cooperative society schemes and certain non-banking deposit products quote simple interest for exactly this reason. It is not dishonest — the number is correct — but it is not comparable to a bank rate, and the comparison is the point.
Converting between the two
To find the compound rate equivalent to a given simple return over t years:
compound rate = (1 + simple total ÷ principal)^(1 ÷ t) − 1
A scheme returning 50% simple over five years — 10% a year, flat — is compounding at 8.45%. A scheme returning 100% over ten years is compounding at 7.18%, not 10%.
Doing this once, before committing, is usually enough to rank two offers correctly, and it is the calculation that marketing material for flat-rate products relies on nobody doing.
Working the formula in each direction
Because there is no exponent, simple interest rearranges cleanly, which is why it survives in classrooms long after it has stopped describing anything you would actually sign.
P = I × 100 ÷ (r × t) — the principal, given the interest paid.
r = I × 100 ÷ (P × t) — the rate, given everything else.
t = I × 100 ÷ (P × r) — the time.
These are worth knowing because they let you check a lender's arithmetic in
seconds. If a moneylender says ₹50,000 borrowed for eighteen months carries
₹13,500 of interest, the rate is 13,500 × 100 ÷ (50,000 × 1.5) = 18%. If they
described it as "₹750 a month", the same calculation names it.
Informal lending in India is quoted almost universally in rupees per hundred per month. Two rupees per hundred per month is 24% a year simple, and five rupees — still common — is 60%. Neither figure is usually stated as a percentage, and converting it is the fastest way to see what is being charged.
The same check works on gold loans, where a monthly rate of 1.5% is presented as modest and is 18% a year before the valuation margin, and on any offer that quotes a total repayable amount without a rate attached. Divide the extra amount by the principal, divide by the years, and the rate appears.
What this calculator assumes
- Interest is charged on the original principal only, for the whole term, with no compounding at any point.
- The rate is annual and the term is in years; a term of six months uses 0.5.
- No payments are made during the term, so the principal never reduces.
- Figures are before tax.
- Where a lender quotes a flat rate, this calculator gives the true interest charged — which is not the same as the reducing-balance rate you should be comparing against.