Simple Interest V/s Compound Interest. Which One Is Best?

Simple Interest V/s Compound Interest. Which One Is Best?

Q: I have ₹ 10,00,000 in my savings account and want to buy a car. Should I buy a car with it or it’s better to take car loan and make a FD from my savings?

Let’s capture everything needed to understand and identify the best option

Interest: It’s the cost we pay on the money we borrowed or the cost we get on the money we invested.

Types of interest: There are two types of interest. Simple interest and Compound interest.

Simple interest is easy to calculate and understand. It’s the cost on the principal amount we borrow or invest.

For example. If you borrow ₹1,00,000 for student loan at 8% simple interest rate for 5 years. Then it will be

1,00,000 * 8/100 = 8000

Principal amount * rate of interest = interest amount

Compound interest is a bit complex because in compounded interest, the interest is paid on the interest along with the principal amount.

For example. If you borrow ₹1,00,000 at interest rate of 8% compounded annually for 5 years. Then

1st year is 28000= 1st year amount+ 8% interest on 1,00,000

20000 + 100000*8/100

2nd year is 28640 = 2nd year amount + 8% interest on (1,00,000+ 1st year interest amount)

20000+ 108000* 8/100 = 28640

3rd year is 29331 = 3rd year amount+ 8% interest on (1,00,000 + 1st and 2nd year interest amount)

20000 + 116640*8/100 = 29331

and so on. So the last payment will be 110833.

The total interest payable was 8000+8640+9331+10077+ 10883 = 46931.

All the house loans , FDs, student loans are having compound interest. The most common example of simple interest is automobile loan and credit cards.

Now let’s get to the question.

If you will buy a car on EMI and invest 10 lacs in FDs . Then:

EMI will be based on simple interest hence it will be ₹536393. Total amount payable will be ₹15,36,393

Now as we know, if you will invest 10 lacs in FDs at the interest rate of 8%. You will be attaining compound interest of ₹12,19,640. And the total maturity amount will be ₹22,19,640.

FD interest calculation as per compounded interest.

So if we do simple maths, FD interest-Car Interest we are left with profit of ₹ 683,247.

And when you are in profitable situation by taking loan, it’s better to take loan rather than going for cash purchase.

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