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Simple Interest vs. Compound Interest Loans

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Potential borrowers often want to find out more about lending options and get to know the difference between simple and compound interest loans. They often get confused about which solution will work best for them.

  • The shortest explanation is that both options are available but lenders prefer to give out a compound interest loan whereas borrowers will benefit more from a simple one.

Remember that it’s important to know not only the interest rate when you are shopping for the best deal but also pay attention to the type of interest.

Here are the basics of these two solutions.

Simple Interest Loans

Let’s start with the definition. This is a type of debt when the borrower has to pay the principal and the interest which is calculated from the principal balance. As it goes from the definition, such kind of debt is typically repaid in monthly equal parts. A lot of installment loans using such a method are popular today. They are more beneficial for borrowers as they won’t pay more in the end.

The formula can help everybody understand and calculate the amount of interest they will need to pay:

Simple interest = (principal) * (rate) * (number of months)

For instance, the simple interest on a loan of $200 at 10 percent interest per year is ($200)*(10)*(12)= 240 simple interest per year.

You can also use a calculator that can be found online if you aren’t sure how to estimate it properly. You just enter the numbers and basic information and receive the result online.

Compound Interest Loans

Now it’s time to understand the notion of compound interest loans. They are more beneficial for the creditors as the borrowers will need to pay more in interest. It’s basically the amount of interest on the principal together with any interest that has been accrued before.

  • What is the compound interest on a three-year, $100,00 loan at a 10 percent annual interest rate?

Now you don’t need to get a headache before you count everything on your own. Many financial websites have calculators that are available for free. This is a great chance to find the right numbers and check if this option is affordable for you.

Main Benefits of Simple Interest Loans

As you can see, simple interest loan amortization works best for common borrowers who don’t want to invest but just need a short-term loan to solve financial problems. Such amortized loan is divided into monthly payments in which one part goes towards repaying the interest while the other part goes towards repaying the balance.

In other words, borrowers can significantly save money in the long run. They can even repay the borrowed money earlier provided that the loan conditions don’t mention the prepayment penalty. Also, it’s possible to pay more than the minimum monthly payment towards repaying the balance.

When you decide to apply for a loan to stay financially afloat, it pays to be responsible and shop around for the best deal with the lowest interest.