Simple Interest: One Formula, No Compounding
A simple interest loan charges interest on the original principal only, for the whole term:
Interest = Principal × Rate × Time. Borrow $20,000 at 10% for 3 years: $20,000 × 0.10 × 3 = $6,000 in interest, fixed on day one. Total repayment: $26,000, or $722/month over 36 months.
Nothing compounds, and nothing recalculates. The interest charge is baked in at signing regardless of how the balance falls. You'll find true simple interest in promissory notes, loans between family and friends, some short-term personal and merchant loans, and certain older auto financing.
Amortized Loans: Interest on the Declining Balance
An amortized loan — mortgages, modern auto loans, most personal loans — recalculates interest every month on the remaining balance. Each fixed payment splits between interest (that month's charge) and principal (which shrinks next month's charge). Early payments are interest-heavy; late payments are principal-heavy; the balance reaches exactly zero on the last payment.
Because the balance falls continuously, you pay interest on less and less money over time.
The Same Loan, Both Ways
$20,000 at 10% for 3 years:
| Simple Interest | Amortized | |
|---|---|---|
| Monthly payment | $722 | $645 |
| Total interest | $6,000 | $3,232 |
| Total repaid | $26,000 | $23,232 |
| Interest recalculated? | Never — fixed at signing | Monthly, on remaining balance |
| Early payoff saves interest? | Often no | Always yes |
Same rate, same term — the simple interest loan costs 86% more. Why? The simple loan charges 10% on the full $20,000 for all three years, even as your payments shrink what you actually owe. The amortized loan only ever charges interest on the money still outstanding. A 10% simple interest loan over 3 years is roughly equivalent to a 17–18% APR amortized loan — which is exactly why some lenders prefer to quote it.
The "Simple Interest Auto Loan" Confusion
Here's where the terminology gets genuinely messy. Most U.S. auto lenders advertise "simple interest" loans — but they mean something different: daily simple interest, where interest accrues daily on the declining balance with no compounding. Functionally, that's an amortized loan, and paying early genuinely saves interest because each day's charge is based on what you still owe.
The test isn't the label — it's the question: is interest calculated on the original principal or on the current balance? Original principal = true simple interest (fixed cost). Current balance = amortizing (early payoff saves money).
The worst variant is the precomputed loan, where total interest is fixed at signing and early payoff refunds are calculated by the borrower-unfriendly "Rule of 78s." If a loan agreement mentions precomputed interest or Rule of 78s, the early-payoff savings you'd expect mostly don't exist. These are legal in some states and common in subprime auto lending.
How to Tell Which Loan You Have
- Read the note for the words "amortized," "interest computed on unpaid balance," "daily simple interest" (all balance-based) versus "precomputed," "add-on interest," or a fixed total finance charge (all principal-based).
- Check whether extra payments change total interest. Call the lender and ask what an extra $1,000 today would save. "Nothing" means the interest was fixed at signing.
- Look at two statements. If the interest portion of your payment shrinks month over month, it's amortizing.
Writing a Fair Family Loan
Simple interest is the natural format for loans between individuals — it's transparent and trivially auditable: everyone can verify P × r × t on a napkin. Two practicalities if you're lending to (or borrowing from) family:
- Put it in a promissory note — amount, rate, term, payment schedule, signatures. It protects the relationship more than the money.
- Mind the IRS minimum rate. Loans above $10,000 between individuals should charge at least the Applicable Federal Rate (AFR) to avoid imputed-gift complications. The AFR is published monthly and is usually far below commercial rates.
Run Both Loans Side by Side
The Simple Interest tab computes P × r × t with a full payment schedule — then compare against the amortized version of the same loan in our Loan Calculator.
Use the Simple Loan Calculator →Payoff Strategy Depends on the Type
- Amortized loan: extra principal payments early in the term have outsized impact — every dollar of principal retired stops compounding against you for the entire remaining term. (Our amortization schedule guide shows exactly why.)
- True simple interest loan: extra payments often save nothing — the interest is fixed. If there's no prepayment benefit, your surplus cash usually does more good elsewhere: higher-rate debt, or investments earning more than 0% marginal savings.
- Daily simple interest auto loan: pay early in the month and extra on principal — both genuinely reduce total interest. Confirm extra payments are applied to principal, not "advanced" to future payments.
The Bottom Line
The label on a loan tells you less than one question: what balance is the interest calculated on? Original principal means the cost is fixed and prepaying is mostly pointless. Declining balance means time is the enemy and every early dollar counts. At the same quoted rate, the "simple" loan is usually the expensive one — a 10% simple interest note costs about what a 17% amortized loan does.
Before signing anything — or lending to anyone — run the numbers both ways: the Simple Loan Calculator for the P × r × t version, and the Loan & Mortgage Calculator for the amortized version. Two minutes of comparison beats three years of overpaying.