What is a Simple Loan?

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  • Written By: Malcolm Tatum
  • Edited By: Bronwyn Harris
  • Last Modified Date: 12 May 2020
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Also known as a simple interest loan, a simple loan is a type of loan arrangement that applies the rate of interest on a daily rather than a monthly basis. While this minor difference makes relatively little impact in the amount that the debtor repays over the course of a short-term loan, the interest paid on a simple loan over a long period of time may be significant. Many consumers who are provided the opportunity to choose between a standard loan and a simple loan will benefit from using a simple interest loan calculator to project the total amount of interest that would be paid over the life of the loan, then compare the interest paid using the standard method. This will make it much easier to determine if the difference is significant and if paying the additional interest is offset by additional benefits found in the loan’s terms and conditions.

With a simple loan, the rate of interest that is applied daily is normally determined by dividing the annual rate by either 360 or 365, depending on the terms specified within the loan contract. That rate is then applied to the loan balance each and every day until the loan is paid in full. This is in contrast to the standard method, which involves dividing the annual rate by 12, then applying that rate to the balance each month. It is not unusual for commercial mortgages to make use of the simple interest method rather than the standard method.

Simple loans that are projected to be repaid in a short period of time, such as a year or so, generally do not create much of a difference in interest paid over the life of the loan. In addition, the provisions within a simple loan may discount or waive other fees that are assessed in a standard loan. This helps to further offset the difference, allowing loans calculated with this method to remain competitive with loans offered by other financial institutions.

Accurately projecting the amount of interest paid on a simple loan becomes much more important when the loan under consideration is for an extended period of time. For example, a consumer who is considering a 30-year mortgage that is structured as a simple loan will want to use a simple interest calculator to project the total amount of interest paid with this approach, then also project the amount of interest paid on a loan using the standard approach. Assuming the other provisions in each loan arrangement are similar in terms of fees and charges, the consumer may find that the total interest paid over the life of the simple loan is significantly higher. When this is the case, going with a mortgage structured with a standard interest application may be the best option.

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