Simple Interest Loan: What Is It and What Are Its Benefits?

When it comes to mastering personal finance, simple understanding interest is the key. This is a fundamental concept that we came across during our elementary days at school. It is only with time that we realize that calculating interest helps us make crucial financial decisions to save our hard-earned money. Simple interest is the interest on the principal amount taken as a loan. If you want to take out loans, you need to understand the simple and compound interest loans. Let’s now have a basic understanding of simple interest loans and what the benefits are.

The Basics

We usually pay two types of interests when paying or borrowing money- simple interest and compound interest. As the name itself says, calculation of simple interest is most comfortable when it comes to determining the extras you would pay for your loan.

It’s the price you pay for borrowing a certain sum of money (principal) in addition to the latter. It would help if you base it on the rate of interest and time. Not just for simple interest, but even for compound interest loan- this fundamental knowledge is vital.

How Is the Calculation Done?

The simple interest calculation is done on the principal times that percentage of the interest every year. The formula goes like this:

Simple Interest= Interest Rate x Principal x Time Period

Simple vs Compound Interest Loans

In a simple interest loan, the interest rate does not change. This means when you repay, you will pay the principal amount and the interest rate.

On the other hand, in a compound interest loan, the interest amount would add to the principal amount. With a compound interest loan, the amount you pay back is much larger than what you initially borrowed. This is because the interest calculation is on the total amount of the loan.

What Is a Simple Interest Loan?

To begin with, anything you borrow from a lender or a bank, you need to repay that – not just the principal amount (the amount borrowed), but also the interest (price for the loan).

A good thing about a simple interest loan is that you can repay the loan in monthly installments. You could do this depending on when you receive your loan. You an amortize these loans by using one portion of the payment for paying off the interest and the other for the principal amount.

With simple interest loans, you won’t end up shelling out interest on the principal interest. This is something borrowers typically have to do if they go for compound interest loans. If you maintain a minimum balance on the credit cards you use, you are possibly paying compound interests. That’s because all the interest charges add up to the principal amount. This way, your debt may grow rapidly over time. On top of it, most credit cards come with a daily, and not monthly, compound interest, which might make your debt grow bigger.

Who Can Benefit With Simple Interest Loans?

The most common example of a simple interest loan is a student loans that utilize the ‘simplified daily interest loans’, wherein interest calculation is only on the balance amount. Also, there are mortgages. First try and learn if the interest calculation is on a daily or a monthly basis. If it is on a daily basis, it is a simple interest loan. However, if it is monthly, it might very well be a negative amortization loan.

Credit cards do not usually come with simple interest schemes. Most of them work on the compound interest principle. It thus results in your debt increasing despite you making the ‘minimum payment.’ Most people often amortize auto and car loans. This means they pay a certain portion of the outstanding loan, while the remaining goes into paying the interest. Apart from these, there are departmental stores too that offer major appliances and gadgets on a simple interest basis for even up to one year.

A simple interest loan is the best type of loan to manage your repayments. You should go for a simple interest loan if you have a steady income and can make monthly payments of the interest and principal. It makes sure you do not get into the spiral of debts.