Simple Interest

Full definition

Simple interest formula: Interest = Principal x Rate x Time For a single period: A $1,000 loan at 10% annual simple interest for 1 year accrues $100 in interest. For 6 months: $50. Contrast with compound interest: Compound interest calculates interest on both the principal and previously accrued (unpaid) interest. Credit cards typically use compound interest on unpaid balances. Savings accounts accrue compound interest in your favor. How simple interest works on an amortizing personal loan: While the term 'simple interest' applies, the mechanics are slightly nuanced: Each day (or each payment period), interest accrues on the current outstanding principal at the daily rate (APR / 365). When a payment arrives, it first covers all accrued interest, then reduces principal. Because principal drops with each payment, the interest charged on the next payment is slightly less - this is what creates the amortization schedule where early payments are heavily interest and later payments are heavily principal. Effect of payment timing on simple interest loans: Paying one day early reduces the interest that accrues to the next payment. Paying one day late increases it. This is why total interest paid on a simple interest loan can vary slightly from the projected schedule based on actual payment dates. Simple interest vs. precomputed interest: Some older or subprime personal loans use precomputed (add-on) interest, where total interest is calculated up front, added to the principal, and divided into equal payments. With precomputed interest, paying off early does not save as much interest because the lender uses the Rule of 78s or similar method to allocate interest front-loaded. Simple interest loans are generally more favorable for early payoff.

• APR (Annual Percentage Rate)
• Amortization
• Principal
• Prepayment penalty
• Per Diem Interest