what types of loans use simple interest 
simple interest usually applies to automobile loans or short term personal loans in the u s most mortgages on an amortization schedule also involve simple interest although they can certainly feel like compound interest loans the compounding feel comes from varying principal payments that is the percentage of your mortgage payment that s actually going towards the loan itself not the interest the interest doesn t compound rather the principal payments do a 1 000 principal payment saves interest on that 1 000 and results in higher principal payments the next year and higher the following year and so on if you don t let the principal payments vary as in an interest only loan zero principal payment or by equalizing the principal payments the loan interest itself doesn t compound if you make partial payments to a simple interest loan the payment will be applied to interest first and any remainder will be used to reduce the principal lowering the interest rate shortening the loan term or prepaying principal also has a compounding effect for example take bi weekly mortgage payment plans biweekly plans generally help consumers pay off their mortgages early because the borrowers make two extra payments a year saving interest over the life of the loan by paying off the principal faster for a short term personal loan a personal loan calculator can be a great way to determine in advance an interest rate that s within your means for longer term loans this calculator may also be of help simple interest vs compound interestinterest can be either simple or compounded simple interest is based on the original principal amount of a loan or deposit compound interest on the other hand is based on the principal amount and the interest that accumulates on it in every period the more frequently interest is compounded quarterly monthly or even daily the greater the total amount of payments in the long run since simple interest is calculated only on the principal it is easier to determine than compound interest compound interest is often a factor in business transactions investments and financial products intended to extend for multiple periods or years typically simple interest is used for loans of a single period or less than a year the formula to determine compound interest involves the same variables as simple interest and is p 1 r n p begin aligned p times 1 r n p end aligned p 1 r n p let s say that you are borrowing 10 000 from bank a to finance an automobile purchase it s a simple interest loan with a rate of 5 and a term of 5 years the amount of interest that you ll owe is 10 000 05 5 2 500 begin aligned 10 000 times 05 times 5 2 500 end aligned 10 000 05 5 2 500 the total amount that you ll pay the lender will be 10 000 2 500 12 500 begin aligned 10 000 2 500 12 500 end aligned 10 000 2 500 12 500 this time you take out a compound interest loan from bank a the essential terms are the same a 10 000 loan 5 interest rate and term of five years in this case the amount of interest that you ll owe is 10 000 1 05 5 10 000 2 762 82 begin aligned 10 000 times 1 05 5 10 000 2 762 82 end aligned 10 000 1 05 5 10 000 2 762 82 the total amount that you ll pay the lender will be 12 762 82 if you d like to calculate a total value for principal and interest that will accrue over a particular period of time use this slightly more involved simple interest formula a p 1 rt a total accrued p the principal amount of money e g to be invested r interest rate per period t number of periods 