how is loan interest calculated by bank?

There are several methods that banks use to calculate the interest on loans, including the simple interest method and the compound interest method.

In the simple interest method, the interest on the loan is calculated based on the principal (original) amount of the loan and the interest rate, and it is not compounded (added to the principal). For example:

If you borrow Rs. 10,000 at an interest rate of 5% per year for a period of 1 year, the interest on the loan will be Rs. 500 (5% of Rs. 10,000).


At the end of the first year, the total amount you will have to pay back will be Rs. 10,500 (Rs. 10,000 principal + Rs. 500 interest).

In the compound interest method, the interest on the loan is calculated on a compound basis, which means that the interest earned is added to the principal and becomes part of the principal for the next period. For example:

If you borrow Rs. 10,000 at an interest rate of 5% per year for a period of 1 year, the interest on the loan will be Rs. 500 (5% of Rs. 10,000).


At the end of the first year, the total amount you will have to pay back will be Rs. 10,500 (Rs. 10,000 principal + Rs. 500 interest).


If the interest rate remains unchanged, the interest earned in the second year will be calculated on the revised principal of Rs. 10,500, which means that the total interest earned in the second year will be Rs. 525 (5% of Rs. 10,500).


The total amount you will have to pay back at the end of the second year will be Rs. 11,025 (Rs. 10,500 principal + Rs. 525 interest).

This process continues until the end of the loan term, at which point the total amount you will have to pay back will consist of the original principal and all the accumulated interest.