What is Simple Interest?
Simple interest is a flat, non-compounding way to price a loan or a short-term deposit. The interest you pay (or earn) is always calculated on the original principal — it never gets added back into the base and re-charged. That makes it much cheaper than compound interest for borrowers and easier to plan around.
The Formula
I = P × r × t
Where I is the total interest, P is the principal (starting balance), r is the annual interest rate written as a decimal (5% = 0.05), and t is time in years. To get the final balance (principal plus interest), use:
A = P(1 + rt)
Worked Example 1: Borrow $10 at simple interest
Small numbers make the formula obvious. If you borrow $10 at simple interest at 6% for 2 years: I = 10 × 0.06 × 2 = $1.20 in interest. You pay back $11.20 total. Double the term to 4 years and the interest doubles to $2.40 — there is no compounding acceleration.
Worked Example 2: $27,000 loan for 5 years
Now scale it up to a car-loan-sized amount. A $27,000 loan for 5 years at 7.5% APR: I = 27,000 × 0.075 × 5 = $10,125 total interest. Total payback is $37,125. On a true simple-interest amortized car loan, your monthly payment would be about $541, and any extra payment goes straight to principal — cutting future interest immediately.
When to Use Simple Interest
- Auto loans: nearly all US car loans use simple interest daily accrual.
- Short-term personal loans and payday-alternative loans with fixed payoff dates.
- Treasury bills and short-term CDs that pay out at maturity without reinvesting.
- Bridge loans and merchant cash advances priced as flat fees.
- Bond coupon calculations between payment dates.
Mistakes to Avoid
- Confusing APR with a flat rate: a "5% flat" personal loan is much more expensive than a 5% APR simple-interest loan because the flat rate is charged on the original balance every year.
- Ignoring daily accrual: car loans accrue interest daily, so paying a few days early each month noticeably reduces total cost.
- Assuming savings accounts are simple interest: almost all US savings accounts and CDs compound at least monthly.
Frequently Asked Questions
Is a car loan simple interest?
Yes — the vast majority of US auto loans are simple-interest, daily-accrual loans. That is why paying extra toward principal reduces your total interest paid.
Can I pay off a simple-interest loan early?
Almost always, yes, and it saves you money. Since interest only accrues on the outstanding principal, cutting the principal cuts every future day's interest. Check for prepayment penalties, but they are rare on modern consumer loans.
Do savings accounts use simple or compound interest?
Compound. Federally insured US savings accounts, money market accounts, and CDs virtually all compound daily or monthly. Simple interest on deposits is mostly limited to short T-bills and some employer-side loans.
What is the difference between APR and APY on a simple-interest loan?
On a pure simple-interest loan they are effectively the same because there is no compounding. APR becomes different from APY only when interest is added to the balance and then re-charged — the essence of compound interest.