Simple interest loans only charge interest on the unpaid principal, which means extra payments directly reduce future interest charges and can shorten the loan term.
Jump to insightThese loans reward on-time and early payments, but can quickly become costly if payments are late due to increased interest and fees.
Jump to insightCompared to compound interest loans, simple interest loans generally cost less because they don’t charge interest on top of interest.
Jump to insightHow does a simple interest loan work?
A simple interest loan only charges interest on the amount of unpaid principal. This type of loan is typically beneficial if you pay your loan on time (or early) each month. And if you make extra payments on the loan, it reduces the principal balance, which will reduce the amount of interest you’ll owe.
A simple interest loan only charges interest on the amount of unpaid principal.
Example: calculating simple interest
With a simple interest loan, it’s easy to figure out how much interest you’ll pay. You’ll multiply the principal amount, which is the original amount you borrowed (or what’s left of it) by the interest rate and the length of the borrowing term.
The formula for calculating simple interest is:
Principal x interest rate x time = interest due
For example, say you take out a $5,000 personal loan with a 6% interest rate and a three-year term. For the first month, you can figure out how much you owe in interest by multiplying $5,000 by one-twelfth of a year (1/12 or 0.083) by 6%, which comes out to $25.
5,000 (principal) x 0.06 (interest rate) x 0.083 (time) = 25
Each month, the interest you’ll owe is calculated again based on the decreasing amount of principal you owe.
» MORE: How to calculate loan interest
Simple interest loan pros and cons
There are both advantages and disadvantages to simple interest loans. Here are some of the pros and cons:
Pros
- Predictable payments
- Paying down principal early saves you money
- Interest doesn’t compound
Cons
- Late payments result in higher interest charges
- Late fees may apply
- Not available with all types of borrowing
What types of loans use simple interest?
A simple interest rate can apply to many types of loans. It may be used on short-term personal loans and some auto loans or mortgages.
Personal loans
Many short-term personal loans, such as those with repayment terms of under three years, are simple interest loans.
Mortgages
Most mortgage loans are simple interest loans, with interest accruing daily or monthly. The exception to this are mortgages that use negative amortization.
Auto loans
Auto loans generally use a simple interest calculation, with monthly payments amortized over a period of two to seven years.
Simple interest loans vs. compound interest loans
With a compound interest loan, the lender calculates interest based on principal and any outstanding interest charges. A simple interest loan is based only on the principal amount of the loan.
For example, credit card companies typically charge interest on the principal amount you owe as well as any interest charges you carry when you don’t pay off your balance in full.
Simple interest loans vs. amortized loans
Many simple interest loans, such as personal loans, car loans and mortgages, use amortization. Amortization is when a portion of each monthly payment is applied to the principal while another part goes toward interest. As the loan term goes on, more of your monthly payment will go toward the principal instead of interest because the principal amount will decrease.
When taking out a loan, you can ask to see the amortization schedule, which shows you the principal and interest distribution of each of your monthly payments.
» MORE: How do loans work?
FAQ
Is a simple interest loan good or bad?
Whether a simple interest loan is good or bad depends on your payment habits. If you make payments on time or early, you can save money on interest, making it a good choice. However, late payments can make it more expensive.
Can I pay off a simple interest loan early?
Yes, you can generally pay off a simple interest loan early. Paying a loan off early or making extra payments reduces the principal, which lowers the total interest owed.
How do I know if my loan uses simple interest?
To see if your loan uses simple interest, check your loan agreement or ask your lender. The agreement will specify how interest is calculated. Simple interest loans are relatively easy to understand, as Antoinette, a reviewer from South Carolina, said in a review on our site about their loan from LendingClub.
What’s the difference between APR and interest rate on a simple interest loan?
The annual percentage rate (APR) combines a loan’s interest rate and fees, while an interest rate is solely the cost of borrowing money. A loan’s APR is generally a more accurate representation of how much a loan will cost.
Bottom line
If you’re considering borrowing money, it’s important to understand not just the interest rate, but also whether the lender is using simple interest or compound interest. Usually, a simple interest loan will cost less than a compound interest loan because the lender only charges interest on the principal and not interest on top of interest.
A simple interest loan also tends to have fixed payments. You can reduce the amount of interest you pay on a simple interest loan by putting extra money toward the principal, but you’ll also end up owing a higher amount if you don’t make payments on time.
Article sources
ConsumerAffairs writers primarily rely on government data, industry experts and original research from other reputable publications to inform their work. Specific sources for this article include:
- Consumer Financial Protection Bureau, “What Is the Difference Between a Loan Interest Rate and the APR?” Accessed Feb. 21, 2026.
