Why simple interest is a rare exception in modern banking
In short: Understanding the difference between simple and compound interest is fundamental to financial literacy. This video explains how simple interest functions as a fixed annual payment and why it is rarely used by actual lenders.
Simple interest is the amount a lender charges a borrower, or a bank pays a saver, as a fee for the use of money. Unlike compound interest, simple interest remains constant; the borrower or saver pays or receives the exact same amount every year.
The calculation is straightforward: you multiply the principal amount by the interest rate and the number of years. For example, borrowing $2,000 at a 4% annual rate for 5 years results in $400 of total interest. However, the video notes that banks almost never use this model, preferring compound interest instead.
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Sources
- Summary by Intellect · source: Simple Interest | Numbers | Maths | FuseSchool
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