Calculating Simple Interest

Simple Interest Loans

A simple interest loan is a loan where the interest is based only on the principal. You can easily calculate your interest using the principal, the interest rate and the loan term.

Simple interest loans can include auto and personal loans, mortgages, and some student loans. If you have any of these loans or plans to borrow, learning more about simple interest can help you understand the true cost.

How Does Simple Interest for Loans Work?

A simple interest loan calculator is an easy way to run the numbers. But if you want to do the math yourself, here's how it works: Multiply the principal by the interest rate by the loan duration to get the interest.

If you have a $10,000 car loan at 6% interest. Assuming a three-year repayment period, the total interest paid using the simple interest method would come to $1,800. That breaks down to $600 in interest paid each year.

Advantages of Simple Interest Loans

Voss Graham, CEO and senior business advisor at InnerActive Consulting Group and former private financial consultant, says simple interest loans are the most cost-effective for borrowers.

"The benefits, in my opinion, are significant since you only pay interest on the principal you owe at any given time period," Graham says. "Plus, you can apply a specific principal payment without paying anything to interest accrued during the life of the loan, thus effectively reducing your interest owed quickly."

That's a plus for you but a disadvantage for lenders. Compound interest loans tend to be more profitable for banks because they may yield more interest from borrowersrs.

Simple interest loans also offer ease of use for borrowers compared with compound interest loans, Dervan says.

"They're often easier for customers to understand, and it's easier for them to perform their own calculations to verify that interest was charged correctly or how much they might have to pay under different scenarios," he says.

Look at the Entire Loan Picture

Before you sign off on any paperwork, read your loan documents carefully to understand how interest is calculated and note questions for the lender, Dervan says. Consider other characteristics of the loan beyond the interest structure, he says, such as:

  • Annual percentage rate
  • Nominal rate
  • Number of days to first payment
  • Monthly minimum payment
  • Loan repayment term
  • Maximum loan amount
  • Late and returned payment fees
  • Late payment policy
  • Origination fees

Graham says to ask the lender if borrowers can make extra principal payments on a simple interest loan and, if so, how those payments are applied. Ideally, extra principal payments would go straight to the principal, rather than the interest, allowing you to pay down the balance faster. In that scenario, you'd also want to know whether the lender charges a penalty for paying off a loan early.

Evaluating these factors together can help you see whether a simple interest loan is the right choice and what it may cost you.

"Customers shouldn't agree to anything they don't feel confident they understand," Dervan says. "The commitment to pay interest charges is an important component of that."

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For more Simple Interest information, please check out the link below.

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