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If you choose to invest in a fixed deposit, you need to have a clear idea of the manner in which your investment will grow over time. In other words, it is essential to understand how fixed deposit interest is calculated. The interest on your FD is calculated primarily on the principal amount that you deposit. Depending on the kind of deposit you choose (namely non-cumulative or cumulative), the interest you earn on your investment can be simple interest or compound interest.

Simple interest is the interest that you earn on your investment amount alone. On the other hand, compound interest is what you earn on your principal as well as on the interest earned so far. In other words, it is interest on interest, which is what the power of compounding represents.

Let’s take a closer look at calculating fixed deposit interest in both cases.

Simple and Compound Interest Formula for FD Interest Calculation

To get a better idea of how fixed deposit interest is calculated, you need to take a look at the mathematical formulae involved. Depending on whether you earn simple or compound interest on your deposit, the formula for how to calculate FD interest also varies, as outlined below.

• Simple Interest Formula for FD Interest Calculation

Simple interest is the return you get from your fixed deposit investment without the power of compounding. Check out the formula for how to calculate FD interest of this kind below.

 Simple interest = (P x R x T) ÷ 100

Here, P is the principal investment amount, R is the rate of interest and T is the tenor in years.

Let’s discuss an example to better understand how fixed deposit interest is calculated in case of no compounding. The table below shows how the simple interest varies across different values for the parameters like the principal, the rate of interest and the tenor.

 Principal Rate of Interest p.a. Tenor Simple Interest ₹10,00,000 5% 1 years ₹50,000 5 years ₹2,50,000 10 years ₹5,00,000 ₹10,00,000 5% 5 years ₹2,50,000 6% ₹3,00,000 7% ₹3,50,000 ₹10,00,000 5% 5 years ₹2,50,000 ₹50,00,000 ₹12,50,000 ₹1,00,00,000 ₹25,00,000

• Compound Interest Formula for FD Interest Calculation

Compound interest is the return that you earn when the power of compounding comes into effect. The formula for how to calculate FD interest of this kind is given below.

 Compound interest = P (1 + r/n)nt - P

Here, P is the principal amount invested, r is the rate of interest, n is the number of times the interest is compounded during a year and t is the investment tenor in years.

If you want to get a better idea of how fixed deposit interest is calculated when compounding comes into play, here’s an example to help you out. Let’s say you invest ₹10 Lakh in a cumulative fixed deposit for a tenor of 5 years and earn interest at the rate of 6% per annum on the same. Say the interest is compounded annually.

In that case, using the formula, here is what we have.

Compound interest:

= P (1 + r/n)nt - P

= 10,00,000 (1 + 0.06/1)1 x 5 - 10,00,000

= 13,38,226 - 10,00,000

= ₹3,38,226

Here is a preview of how the compound interest will be calculated for each year.

 Year Opening balance Rate of Interest Interest Earned for the Year Closing Balance 1 ₹10,00,000 6% ₹60,000 ₹10,60,000 2 ₹10,60,000 6% ₹63,600 ₹11,23,600 3 ₹11,23,600 6% ₹67,416 ₹11,91,016 4 ₹11,91,016 6% ₹71,461 ₹12,62,477 5 ₹12,62,477 6% ₹75,749 ₹13,38,226 Total Interest Earned ₹3,38,226

Now that you know how fixed deposit interest is calculated, you may be wondering how you can get the best FD returns. After all, the better the interest rate, the higher the returns, isn’t it? Here are some essential tips to get optimal returns on your fixed deposit.

• Consider NBFC Fixed Deposits

Although they carry a slightly higher level of risk, NBFCs typically provide higher returns than bank FDs. So, if you find a trusted NBFC like Bajaj Finance, you can definitely opt for it to avail more optimal returns.

• Compare FDs Before Investing

Always compare FDs plans from different banks and NBFCs and go for the one that gives higher returns on your investment amount. You can use an FD calculator for  calculating fixed deposit interest across different plans before you make a choice.

• Opt for a Cumulative FD

Once you choose the plan that provides the best FD rates, you need to maximise your returns. If you choose to go for the cumulative option, you will receive your entire interest on your principal amount on maturity. The compounding effect of cumulative FD results in higher returns too.

• Submit Form 15G/15H

In case your total income during the year does not exceed the basic exemption limit, you can submit form 15G (or form 15H if you are a senior citizen) to avoid TDS on FD interest. This will maximise the amount that is credited to your account from your FD investment.

Conclusion

This should give you a fair idea of how fixed deposit interest is calculated, and what you can do to make the returns on your FD optimal. Before you make any investment in a fixed deposit, ensure that you make use of an FD interest calculator to get a better idea of how your investment will grow over time.

FAQs

✔️What parameters are used to calculate interest on FD?

The FD interest depends on three key factors, namely your investment amount, the rate of interest and the tenor of investment. In case of compound interest, the frequency of compounding also affects the returns earned.

✔️How to calculate FD interest using an online calculator?

To calculate your FD interest using an online FD interest calculator, you need to enter different parameters like the deposit amount, the rate of interest, the frequency of compounding and the tenor of investment. The online tool will then compute the interest earned and the maturity amount.

✔️Why is it important to understand how fixed deposit interest is calculated?

It is important to understand FD interest calculation because you can make smarter investment decisions that way. Once you know how your money grows in an FD, you can choose the ideal deposit plan, the tenor and the type of deposit (namely cumulative or non-cumulative).

✔️What is the difference between the calculation of simple interest and compound interest?

Simple interest is computed only on the principal amount and it does not benefit from compounding. Compound interest, on the other hand, is earned on the principal amount as well as the returns earned so far. In other words, it is interest on interest. Cumulative FDs offer the benefit of compound interest.