# Simple Interest and Compound Interest: Understand the Difference

What is the difference between simple interest and compound interest? A recent survey by the National Association of Finance, Administration and Accounting showed that 99.5% of Brazilians do not know the concept of compound interest.

Let’s see: simple interest is calculated based on the initial capital and compound interest is calculated on the current value of the capital, which is already with interest, and that is why it is “interest on interest.” As the name suggests, simple interest is the sum of capital plus income.

Compound interest is present in loans , investments, credit card revolving credit , overdraft , among other transactions.

From this comes the question: why do compound interest exist in these transactions? Roughly, interest is the price of money applied or borrowed, that is, they work as if they were a fee for the credit granted, as in the case of minimum payment of the credit card: the debtor balance is a credit and has a high rate of interest, the largest of all credit modalities.

## How to calculate simple interest?

Next, learn how to calculate simple interest in a practical way:

• Initial value: is the amount that interest will be applied
• Interest rate : is the percentage of interest (it is necessary to divide the value by one hundred, to find the decimal)
• Time of interest application : it is the time that the interest will be applied (always in months)
• Future value : is the sum of capital (initial value + interest applied)

Formula to calculate simple interest:

• Interest = initial value x interest rate x interest rate

Let’s take a practical example:

Initial value: R \$ 1,300.00

Interest rate applied: 0.08% (8 divided by 100)

Time of interest application: 5 months.

Calculation of simple interest using the formula above:

Interest = R \$ 1.300 x 0.08 x 5 = R \$ 520.00

Future value: R \$ 1,300.00 (initial value) + R \$ 520.00 (interest) = R \$ 1,820.00

## How to calculate compound interest?

Next, learn how to calculate compound interest in a practical way:

• Initial value: is the amount that interest will be applied.
• Interest rate : is the percentage of interest (it is necessary to divide the value by one hundred, to find the decimal)
• Time of interest application : it is the time that the interest will be applied (always in months)
• Future value : is the sum of capital (initial value + interest applied)

## What is the basic interest rate?

The Selic rate is the basic interest rate of the Brazilian economy and serves as a parameter for the interest rates charged by banks and financial institutions in the various credit modalities and also in investment income.

As of 1999, the Selic rate came to be used as Brazilian monetary policy and aims to control inflation in the country and influence economic activity.

The Selic also influences the interest the government pays for borrowing from banks. The Monetary Policy Committee (Copom), of the Central Bank, is responsible for defining, every 45 days, the basic interest rate in the economy.

The increase in the Selic interest rate hampers the recovery of the economy, while the fall of Selic preserves the purchasing power of Brazilians.

## Why are interest rates high in Brazil?

It is the way that the Brazilian government finds to keep the country’s inflation under control.

Interest rates are high in Brazil because very low interest rates can have a drastic impact on the prices of various consumer products, which tend to rise rapidly due to high demand.

Regarding credit modalities, the risks associated with operations motivate banks to charge higher rates, such as the credit card and special check, which are considered as emergency loans.

Bank spread, which is the difference between what banks pay for resources and what they charge their customers, also motivates institutions to charge high interest .

## How to pay less interest?

There are cheaper credit modalities in Brazil, with lower interest rates than credit cards and overdrafts, which lead to the highest interest rate in the country.

The personal loan has an interest rate ranging from 0.80% to 27.24% per month, according to data from the Central Bank (BC), during the period consulted (May 28 to June 4, 2018).

At Credit lender, with a single registration, you can apply for your personal loan for free to all financial institutions and evaluate the best personal loan proposals according to your profile.

This makes it easy to find credit with interest that does not weigh on your monthly budget and still helps you organize your expenses .