In essence, we use simple interest to calculate the additional compensation due on the initial principal only. That is to say that we will ignore the value of interest (over time) in our calculation. By and large, this is commonly used for car loans in Singapore. Despite that term, simple interest may not be that simple after all. Therefore, let’s find out more about how it works.

Table of Contents:

1. The Formula
2. Sample Calculation
3. Real Life Application
4. Conclusion

One Minute Summary:

• Simple interest accounts for the additional compensation due on the initial principal only.
• For the most part, this declared rate is usually low and attractive. However, the opposite is true in reality.
• Generally, simple interest works in your favour when you are a borrower. On the other hand, compound interest is better when you are an investor.

Part 1: The Formula

To begin with the formula, simple interest is the multiplication of the principal, the rate, and time period. In detail,

• Simple Interest ($): The compensation on the principal in return for the time spent;
• Principal ($): The initial amount of money involved in the situation;
• Interest Rate (%): A fixed percentage charged for the situation;
• Time (years): The period when the situation occur.

Part 2: Sample Calculation

Given that formula, let’s go through two examples together.

Part 2.1: Example 1

As an illustration, let’s invest $100,000 into an instrument that yields a rate of 10% for 6 years. As a result, simple interest = $100,000 x 10% x 6 years = $60,000. Altogether, you will receive $100,000 + $60,000 = $160,000 at the end of 6 years.

Part 2.2: Example 2

Next, let’s invest $100,000 into an instrument that yields a rate of 10% for 6 months. Accordingly, simple interest = $100,000 x 10% x 6/12 years = $5,000. In sum, you will receive $100,000 + $5,000 = $105,000 at the end of 6 months.

As you may have noticed, we took 6 months / 12 months for the time period. This is because we need to convert the unit for the time period into years. Otherwise, the formula will not work. Hence, do bear that in mind when you perform the calculation.

Part 3: Real Life Application

As I have noted earlier, simple interest is commonly used for car loans in Singapore. For example, a brand new Toyota Vios costs $88,888 (as at 3 January 2021). In this situation, let’s make a downpayment of 30% for the car. Thereafter, we will take up a 7 years loan at 1.99% per annum.

• Downpayment = $88,888 x 30% = $26,666.40
• Loan Amount = $88,888 x 70% = $62,221.60
• Simple Interest = $62,221.60 x 1.99% x 7 years = $8,667.47

In sum, I will need to pay a total interest of $8,667.47 for borrowing $62,221.60.

Part 4: Conclusion

In summary, we need to evaluate the situation before we determine whether simple interest is a boon or a bane. For instance, we won’t fancy such computation when we are an investor. This is because you won’t receive any additional compensation for the interest that you have earned over the years.

While this may be true, simple interest is great when you are a borrower. For the same reason, you don’t need to pay additional interest for the amount that you borrow. After all, the interest is calculated based on the initial principal only.

Despite that, I will highly suggest for you to convert this to its effective interest rate. This will undoubtedly give you a clearer picture on the real cost to that end. As an illustration, a car loan at 1.99% per annum for seven years is effectively 3.77% per annum! By taking a second look, you will realise the real rate that you are paying for that ‘cheap’ loan!

First Published: 25 September 2019
Last Updated: 5 January 2021