Simple Interest Calculator

Most auto loans use simple interest calculated daily on the outstanding balance, meaning paying early or making extra payments directly reduces your total interest cost. Many short-term personal loans under 12 months also use simple interest. Certificates of deposit and savings accounts typically use compound interest, usually compounded monthly or daily. Credit cards use compound interest calculated daily on your average daily balance, which is why credit card debt grows so rapidly. Mortgages in the US use a form of compound interest through amortization, though the monthly calculation resembles simple interest on the remaining balance.

For periods less than a year, you adjust the time variable T in the formula. For months, divide by 12. For a $10,000 loan at 12 percent annual interest for 6 months, T = 6/12 = 0.5, so interest = $10,000 x 0.12 x 0.5 = $600. For days, you can use either a 365-day or 360-day year depending on the lender convention. Many financial institutions use a 360-day year for simplicity, so a 90-day loan would use T = 90/360 = 0.25. The 360-day method slightly favors the lender since you are paying for 360 days of interest while the actual period is 365 days.

Simple interest is generally better for borrowers because the total interest paid is lower than what compound interest would produce over the same period. On a $20,000 loan at 8 percent for 5 years, simple interest costs $8,000 total while annual compounding would cost $9,332, a difference of $1,332. For lenders, compound interest generates more revenue, which is why banks prefer it for savings accounts and credit cards. However, simple interest loans can still be profitable for lenders on large volumes and short terms. The simplicity and transparency of simple interest also makes it attractive for both parties since calculations are easy to verify.

Simple interest calculations are excellent for comparing loan offers, especially when the terms are similar. If Lender A offers $25,000 at 7 percent for 4 years and Lender B offers the same at 6.5 percent for 5 years, the simple interest comparison shows A costs $7,000 in interest while B costs $8,125, making A the cheaper option despite the shorter term. However, be cautious when comparing loans with different compounding methods. A loan advertised at 8 percent simple interest is not directly comparable to one at 8 percent compound interest. Always convert to the same basis or use the APR for accurate comparisons.

This is a crucial distinction that many borrowers miss. Simple interest is calculated on the outstanding balance, so as you pay down principal, your interest decreases. Flat interest rate, common in some personal and business loans, calculates interest on the original principal for the entire loan term regardless of how much you have already repaid. On a $10,000 loan at 10 percent for 3 years, flat interest charges $3,000 total interest even after you have paid back half the principal. The effective interest rate on a flat-rate loan is nearly double the stated rate. Always ask your lender whether the quoted rate is simple or flat.