What is the difference between simple interest and compound interest?

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Answer By law4u team

The difference between simple interest and compound interest lies in how the interest is calculated and added over time. Here's a clear explanation in plain terms: 1. Simple Interest (SI) Simple interest is calculated only on the original principal amount throughout the loan or investment period. The interest does not increase because it doesn’t get added to the principal. Formula: SI = (P × R × T) / 100 Where: P = Principal (initial amount) R = Rate of interest per annum T = Time (in years) Key Points: Interest stays the same every year. Total interest is directly proportional to time. Easy to calculate and understand. Example: If ₹10,000 is invested at 10% simple interest for 2 years: SI = (10,000 × 10 × 2) / 100 = ₹2,000 Total amount = ₹10,000 + ₹2,000 = ₹12,000 2. Compound Interest (CI) Compound interest is calculated on the principal plus the accumulated interest from previous periods. This means interest is added to the principal each time it is calculated, and the next interest is calculated on this new amount. Formula (annual compounding): CI = P × (1 + R/100)^T – P Where: P = Principal R = Rate of interest per annum T = Time in years Key Points: Interest gets added to the principal. Interest increases over time (because of compounding). Returns are higher than simple interest for the same principal, rate, and time. Example: If ₹10,000 is invested at 10% compound interest for 2 years: Amount = 10,000 × (1 + 10/100)^2 = 10,000 × 1.21 = ₹12,100 CI = ₹12,100 – ₹10,000 = ₹2,100 Main Differences: Simple Interest: Interest is always calculated on the original principal. Compound Interest: Interest is calculated on principal + previous interest. Growth: Simple interest grows linearly; compound interest grows exponentially. Returns: Compound interest gives higher returns than simple interest over time. In practice, banks and financial institutions usually use compound interest for savings and investments, while simple interest may be used in some short-term loans or schemes.

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