Updated: Sep 17, 2021
Many of us don't understand how interest is charged on loans. Let's take a look.
Simple interest is calculated purely on the initial amount borrowed – the principle. Simple interest, the interest you pay, is the rate times the principal, times the loan time.
For example: Tony needs a new car, and requests an unsecured loan to cover the cost of $10,000 loan. His credit score is good, so the bank approves him for the $10,000 loan, the principal, given he returns the money within the loan period: 5 years’ time. They charge an annual interest rate of 4%.
Calculate the total interest by multiplying the loan amount by the 4% interest rate by the number of years that you’re carrying the loan. ($10,000 x .04 = $400 x 5 years = $2,000)
Completing the calculation, we would get $12,000 as the total that Tony needs to pay back. ($10,000 principle + $2,000 interest = $12,000. Note, other car fees, taxes, dealer prep, not included.)
Frankly, simple interest on loans is a very good thing for your finances. In contrast to credit cards, which use compound interest, simple interest loans only calculate interest on the initial principal. This makes the debt more manageable.
That's why it can sometimes be recommended to take out a personal loan to pay down a credit card debt.
For more information on financial strategies, contact Stevie Swain at Swain Consulting, 513-818-1753, ext. 4.