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If you’re looking at personal loans, mortgages, or car financing, you’ll want to know two key things — the interest rate and how the interest will be calculated.Interest is either simple or compound. With a simple interest loan, the interest is based only on the principal (amount of the loan). With a compound interest loan, you pay interest on the principal plus any interest that has accrued. Because you don’t pay any interest on the interest, a daily simple interest loan can end up costing less, provided you make your payments on time.Here’s what you need to know about how daily simple interest loans work.Daily Simple Interest (DSI) Defined
A simple interest rate is called “simple” because it is based on a simple calculation: the principal times the percentage of interest per year times the number of years of the loan.Here's the formula:Simple Interest = Interest Rate x Principal Balance x Time PeriodA daily simple interest, or DSI, rate is based on the same principle, except it takes the annual interest rate and divides it by 365 (days in a year) to come up with a daily interest rate. For each day after your bill is sent, you accrue interest. With a DSI loan, your interest is calculated by multiplying the daily interest rate by the principal balance (how much you have left to pay on your loan) and then by the number of days since your last payment (typically 30 if you pay monthly).The formula looks like this:Daily Simple Interest = Daily Interest Rate x Principal Balance x Time Period Simple Interest vs. Other Types of Interest Rates
With simple interest, the amount of the principal and the rate of interest don't change over the life of the loan. That means the principal balance used to calculate the interest due doesn't increase based on interest charges.Compound interest, however, is more complicated. With compound interest, the interest that has accumulated on the principal in every period is added to the principal amount. As a result, you end up paying interest on the accumulated interest. You can calculate compound interest, but the formula is fairly complex compared with the one for simple interest. However, there are online compound interest calculators that can make this easy to do. Since you’re not paying interest on the interest, a simple interest loan typically costs less, depending on how much you borrow, the loan term, the interest rate, and any fees.How Daily Simple Interest Loans Work
Simple interest loans are paid back in equal, monthly installments that are determined when you receive the loan. That's why you may have coupon books or electronic reminders of your monthly payment for the life of your loan.When you make your monthly payment on a DSI loan, the payment first goes toward the interest you owe for the past month, and the rest goes toward paying down your principal balance. The interest for the month is paid in full, so it does not continue to accumulate.If you pay your bill on time, the lender calculates your interest on the 30 days of the month prior. If you pay your bill early, you’ll pay less in interest than if you wait until just before the due date. If you pay your bill late, on the other hand, you’ll pay more in interest (since more days have accumulated), and you may also incur a late fee.How to Calculate Daily Simple Interest
Here’s an example to illustrate how to calculate daily simple interest on a loan. Let’s say you were to borrow $12,000 at an annual interest rate of 6% and will repay it in three years. You’ll pay $2,160 ($12,000 x 6% x 3) in interest over the life of the loan. Your monthly payments (principal plus interest) will be $393. To calculate your DSI, you’ll use this formula:Daily Simple Interest = Daily Interest Rate x Principal Balance x Time PeriodBefore we use this formula, we need to calculate the daily interest rate. To do that, we take the 6% interest and divide it by 365 days to get .000164. Now we plug that into our formula:12,000 x .000164 x 30 That means $59 is owed in interest the first month. So out of your $393 payment, $59 will go towards interest and $334 will go toward principal. Over time, however, less of your monthly payment will go toward interest (as your balance goes down, the “P” in the above equation will be a little smaller each month), and more of your payment will go toward principal.This is assuming you always make your payments on the due date. For example, If your payment is due on October 1 and you pay it precisely on the due date, the finance company calculates your interest on the 30 days in September. However, if you make the payment earlier, say September 20th, the finance company charges you interest for only 20 days in September, which means less of your payment would go towards interest and more toward principal. If you pay later than October 1, on the other hand, then you’ll pay more in interest and less of your $393 payment will go toward your principal. In addition, you may incur a late fee. Pros and Cons of Daily Simple Interest Loans
Is a simple interest loan right for you? Let’s look at the benefits and drawbacks.| Pros | Cons |
|---|
| Easy to calculate | Can be hard to find |
| Typically costs less than a compound interest loan | Late payments lead to added interest charges |
Pros of Daily Simple Interest Loans
If math isn’t your forté, you might get cross-eyed trying to calculate what you’d pay with a compound interest loan, but simple interest loans are easy to figure out.And, if you make your payments on time, you will typically end up paying less interest with a simple interest loan than you would with a compound interest loan. If you’re able to make your payments early and/or make extra payments, you can save even more.Cons of Daily Simple Interest Loans
Not every lender offers simple interest loans, so finding one can sometimes be a challenge.Another downside is that If you're late with a payment, you will accrue more interest. Even if you’re just one day behind schedule, a greater portion of your payment will go towards interest. This can affect your loan schedule, potentially adding more time to pay off your loan and making the loan cost more than you anticipated. Types of Daily Simple Interest Loans
Below are some of the loans that may offer daily simple interest.Auto Loans
A simple interest loan is one of the most common types of financing for an auto loan. Because the interest rate is based on the outstanding balance, borrowers can typically save on interest by paying more than the monthly car payment.A car loan is usually a secured loan, meaning the vehicle is collateral on the debt. If you don’t make payments, the lender can seize the vehicle.Personal Loans
A personal loan is a type of loan that typically allows for flexible use, has short- to moderate-term repayment options, and offers relatively quick funding. And, there are many types of personal loans that use simple interest. Mortgage Loans
Mortgages are typically considered simple interest loans because they are not compounded (meaning you likely won’t pay interest on the interest). However, very often the interest on a mortgage is calculated on a monthly basis, rather than on a daily basis, though there are some DSI mortgages available.The Takeaway
Daily simple interest loans are ones where interest accrues daily on the unpaid principal balance. As the principal balance is reduced, the interest charges go down because less interest accrues on a smaller principal balance. While it may not sound exactly “simple” at first, the key thing to understand with these types of loans is this: If you make your loan payments on time, you can avoid paying any additional interest charges and will pay your loan off as scheduled. And, if you pay early, you may be able to reduce the total cost of your loan.If you’re ready to start shopping for a personal or other type of loan, Lantern by SoFi can help — our online tool makes it easy to compare offers from multiple lenders side-by-side in just a few minutes.
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About the Author
Susan Guillory
Susan Guillory is the president of Egg Marketing, a content marketing firm based in San Diego. She’s written several business books, and has been published on sites including Forbes, AllBusiness, and Cision. She enjoys writing about business and personal credit, financial strategies, loans, and credit cards. Follow her on Twitter @eggmarketing.
