What Is a Simple Interest Loan?


Quick Answer

A simple interest loan is one where interest is determined by multiplying the interest rate times the principal times the number of periods. The reason that simple interest is referred to as simple is because it ignores the effects of compounding.

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Full Answer

The interest charge on a simple interest loan is always based on the original principal amount, so there is no interest that accrues on the original interest amount. This method is used more in short-term loans than in long-term loans due to the fact that the formula does not account for compounding.

The formula for simple interest is SI = P x I x N, where SI stands for simple interest, P stands for the principal amount, I stands for the amount of interest and N is the duration time of the loan in periods.

When paying back a simple loan, it is paid in equal installments as interest accrues on the outstanding balance. The money for each payment goes partly to paying the interest on the loan for that period as well as paying for a portion of the outstanding balance on the loan. The payment is adjusted so that after a certain number of payments, both the interest and principal amount are paid back and the outstanding balance is zero.

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