What Is A Simple Interest Loan?
When it’s time to purchase a new car, most people take out an auto loan. This type of loan is considered a simple interest loan. This is the type of loan that Greater Texas Federal Credit Union offers.
You may be wondering how a simple interest loan works?
There are three components to a calculate simple interest loan:
1. Principal, or the amount financed or borrowed
2. Interest rate, or the cost of borrowing the money
3. Time, or your loan term
Typically the term of your loan is written at a fixed rate. This means that your annual percentage rate (APR) or the interest you pay, remains the same throughout the term of your loan.
The finance charge you pay is based on the number of days and the dollar amount that the unpaid balance is outstanding.
When you first start making payments on your loan, a higher percentage of your fixed monthly payment goes towards the interest. And, what is leftover goes towards the principal.
As you continue to make full and on-time payments every month, a higher percentage of your loan payment will be applied to the principal and less to interest each month until your loan is ultimately paid off.
So, why is that?
The interest is calculated against your loan’s outstanding principal or balance. At the beginning of the loan, the outstanding principal is large, therefore so is the interest. But, as time goes on and you start paying down your principal, the amount of interest you pay every month goes down with it. More and more of your fixed payment will go towards the principal rather than interest.
It’s also important to note that on a simple interest loan that your interest accrues daily based on your outstanding balance. Since interest accrues daily, when you make your payment makes a difference. If you make your monthly payment exactly on your due date, you’ll pay the exact amount of interest that you had originally planned. However, if you make a payment before your due date, less interest will accrue, so more of your fixed payment will go towards the principal. On the flip side, if you make your payment late, more interest will accrue, so more of your payment will go towards interest and less towards principal.
Here’s an example:
• Amount borrowed is $20,000
• Interest rate, or APR, is 5.9%
• Fixed monthly payment is $386
Your daily finance charge would be calculated as follows:
($20,000 x 5.9%)/365 days per year = $3.23/day
If your $386 payment is received exactly 30 days from the date of your last payment, your finance charge for that period would be $96.90 ($3.23 x 30 days).
Your $386 payment would be divided between principal and the finance charge:
Finance Charge: $96.90
If you make your next payment exactly 30 days later, the principal amount would be higher and the finance charge would be lower.
Pretty simple, right? If you have additional questions, please contact our Loan Department at (800) 749-9732 ext. 1002.