Simple interest

What It Means

Simple interestInterest rateThe yearly percentage a lender charges for borrowing money, not counting fees; the APR adds certain fees to show a fuller cost. See more is interest worked out on the principal alone, never on interest already added. The term is used two ways. (1) On savings or an investment such as a brokered CDCertificate of depositA deposit you agree to leave at a bank or credit union for a set term, until its maturity date, usually with a penalty for taking money out early. See more, the interest is based only on the original amount, so it pays the same dollars each year. (2) On a simple interest loan, such as many car loansCar loanAn installment loan used to buy a vehicle, repaid in monthly payments over a set term, with the vehicle as collateral. See more, interest is figured daily or monthly on the balance you still owe on the day the payment is due, so paying early or paying extra cuts the interest.

How It Sounds at Home

• "It's a simple interest loan, so paying early saves me money."
• "The interest is only on what I borrowed."
• "Every extra payment goes straight to principal."

The Breakdown

Formula. Simple interest = principal × yearly rate × years.

Worked example. $2,000 at an example 4% simple interest for 3 years:

Each year pays the same $80, because the interest is always figured on the original $2,000. With the same rate compounded yearly, three years would earn $249.73, since years two and three would also pay interest on interestCompound interestInterest paid on your original amount and on the interest it has already earned, so each year's interest is a little bigger than the last. See more already added.

On a simple interest loan. Take an example $15,000 car loan at 6%. Interest builds at about $2.47 a day on that balance. Pay 30 days after the last payment and $73.97 of a $350 payment goes to interest; pay 5 days late, at 35 days, and it's $86.30, leaving less for the balance.

What the result means. On savings, simple interest grows more slowly than compound interest at the same rate. On a loan it works in your favor when you pay on time or early, because interest is only ever charged on what you still owe, and every dollar of principal you pay down stops earning interest for the lender.

Good to Know

The CFPB's Ask CFPB answer on auto loans explains that a simple interest loan works out interest daily or monthly on the balance you still owe on the day the payment is due, while precomputed interest is set at the start of the loan; your contract says which method yours uses. Paying more than the monthly amount on a simple interest loan makes the principal smaller, the CFPB notes, so less interest builds after that. For savings, Investor.gov's bulletin on brokered CDs says they generally pay simple interest rather than compound, so compare their yield carefully with a bank CD's APYAPYA yearly rate showing the total interest a deposit account pays, counting how often interest compounds, as defined by federal Truth in Savings rules. See more.

Related Terms and Categories

• Compound interest

  Interest paid on your original amount and on the interest it has already earned, so each year's interest is a little bigger than the last.

• Interest rate

  The yearly percentage a lender charges for borrowing money, not counting fees; the APR adds certain fees to show a fuller cost.

• Amortization

  Paying off a loan through regular scheduled payments, each split between interest and principal, until the balance reaches zero at the end of the term.

• APY

  A yearly rate showing the total interest a deposit account pays, counting how often interest compounds, as defined by federal Truth in Savings rules.

• Certificate of deposit

  A deposit you agree to leave at a bank or credit union for a set term, until its maturity date, usually with a penalty for taking money out early.

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