What is a Simple Interest Loan?
Most people use loans to help cover the cost of large purchases. For example, when it’s time to purchase a new car, auto loans are available so buyers don’t have to pay the entire amount upfront. This type of loan is considered a simple interest loan, which is the type of loan that Greater Texas Credit Union offers.
You may have heard the term and have a pretty good idea of the way it works. But you’re not alone if you have some questions. We’ll answer a few common questions about these loans, how they work, and different options available to borrowers and Greater Texas Credit Union members.
What Is Simple Interest?
Simple interest is the term for the way that the interest charge on a loan is calculated. It’s in contrast to compound interest, which we’ll explain later on. But essentially, its calculation isn’t affected by the number of previous interest payments.
How is Simple Interest Calculated?
There are three components to a calculate simple interest loan:
- Principal, or the amount financed or borrowed
- Interest rate, or the cost of borrowing the money
- 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 life of the 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.
How This Type of Interest Works
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, 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.
Compound Interest Loans
This type of interest is different, in that interest continues to accrue in addition to whatever interest has already accrued on the principal. This can work to your advantage when you’re saving, as you can accrue more money in your account.
However, when you have a loan with compound interest, you could end up paying more over your loan, typically on credit cards. With a card balance, you can pay interest that compounds as often as every day, on a monthly billing cycle.
Why Is It Called Simple Interest?
Unlike compound interest, simple interest rates stay the same over the course of the loan term.
Other Types of Loans That Use Simple Interest
We used the example of auto loans earlier. But aside from car loans, what types of loans use simple interest?
Common examples include:
These loans, frequently at fixed interest rates and set monthly payments, help you to budget and plan accordingly.
Borrow with Greater Texas Credit Union
Greater Texas Credit Union offers its members a variety of simple interest loan products. From personal loans to auto loans to mortgages at competitive rates, you can borrow to achieve your personal or financial goals.
As a credit union, we’re a member-owned nonprofit. That means instead of sending our profits to faraway investors and shareholders, we return them right back to our borrowers. As a result, our members enjoy lower interest rates on loans than from commercial banks, and higher dividends on savings accounts.
We also offer a range of credit cards, including:
- Rewards VISA
- Classic VISA
- Share Secured VISA
- Business VISA
With no annual fee and competitive interest rates, each card comes with benefits and features that will help you take charge of your finances. No matter your credit history or goals, we can help you find the right card to meet your needs.
Pretty simple, right?
If you have additional questions, or to learn more about our loan products and services, we’re happy to answer them.
To learn more about our rates, terms, products, and services, please contact our Loan Department at (800) 749-9732.