Glossary term
Simple Interest
Simple interest is calculated only on the original principal, never on interest already earned or charged. The formula is principal × rate × time. Because interest does not build on itself, simple interest grows in a straight line, which makes it easy to predict and generally cheaper for borrowers than compounding.
Updated October 17, 2026 · Editorial Team
How Simple Interest works in practice
With simple interest you multiply three numbers: the principal, the annual rate as a decimal, and the time in years. Each year adds the same dollar amount. Many auto loans and personal loans use simple interest on the current balance, computed daily or monthly, so paying early cuts the interest you owe.
Put $5,000 at 5.00% simple interest for three years. Interest is $5,000 × 0.05 × 3 = $750.00, and the total grows to $5,750.00. Compare that with annual compounding, where the same deposit would reach $5,788.13 because each year's interest earns interest too.
For borrowers, simple interest is usually the friendlier method because unpaid interest is not added to the principal. For savers, it is the less generous one. Knowing which method applies helps you predict the balance and see why paying extra early saves money.
Simple Interest: quick questions
What is the simple interest formula?
Interest = principal × annual rate × years. For example, $2,000 at 6% for two years is $2,000 × 0.06 × 2 = $240.
Are car loans simple interest?
Many are. Interest accrues on the current balance, so paying early or extra lowers the interest you pay. Check your contract to confirm.
Is simple interest better than compound interest?
For a borrower, usually yes, because interest does not pile onto itself. For a saver, compounding earns more.
Sources
- Compound interest (glossary) — U.S. Securities and Exchange Commission (Investor.gov). Accessed October 17, 2026.
- Regulation Z (Truth in Lending), 12 CFR Part 1026 — Consumer Financial Protection Bureau. Accessed October 17, 2026.
We cite primary sources: regulators, central-bank data and federal agencies. Worked examples on this page are our own calculations. See our methodology.
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