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Simple interest is calculated on a principal amount using the interest rate and time: I = P × R × T. It is a useful way to understand interest, but it does not necessarily predict every payment on a real loan: many loans calculate interest on the outstanding balance as it changes.
How the simple-interest formula works
The standard educational formula is I = P × R × T, where:
- I is the interest amount.
- P is the principal: the amount borrowed or invested.
- R is the interest rate written as a decimal.
- T is the time, measured in units that match the rate period.
For an annual rate, time is usually expressed in years. Convert a percentage to a decimal by dividing it by 100; for example, 5% becomes 0.05.
Worked example
Suppose you borrow $1,000 at 5% per year for two years. The calculation is $1,000 × 0.05 × 2 = $100 in interest. Adding that interest to the principal gives $1,100 before fees or other contract terms. This is an illustrative calculation, not a quote for a particular loan. A basic calculator can help check the multiplication.
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The CFPB presents this formula as a simplified approach and cautions that actual loan calculations are likely to be more complicated: CFPB, Building Blocks Teacher Guide: Calculating Loan Payments.
Why a real loan may not follow the one-line calculation
The formula treats principal and time simply. For an auto loan using simple interest, however, the CFPB says interest is calculated on the outstanding balance, daily or monthly. As payments reduce principal, the balance used to calculate later interest falls. The amount and timing of payments therefore matter to the loan’s interest over time.
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With precomputed interest, the lender calculates total interest at the beginning and distributes it across payments. Extra payments or early payoff can have different consequences than with an outstanding-balance method; some unearned interest may be refunded. The contract and payoff information determine how a particular loan works, so the classroom formula alone cannot establish the amount due at a given point. See the CFPB’s explanation, last reviewed January 30, 2024: simple interest versus precomputed interest on an auto loan.
Simple interest rate and APR are not the same
An interest rate describes the cost of borrowing expressed as a rate. APR includes the interest rate plus additional fees charged with the loan, according to the CFPB. Because the measures include different costs, do not compare one loan’s APR directly with another loan’s interest rate. The CFPB recommends comparing APR with APR when shopping: CFPB, interest rate versus APR (last reviewed August 28, 2026).
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The loan term also affects comparisons. A fee charged over a very short borrowing period can translate into a much higher annualized rate; the CFPB uses payday loans to explain why APR can help compare costs across products with different terms: CFPB, APR and payday-loan interest rates (last reviewed November 25, 2024).
Independent reader supportYour contribution helps us test, update, and keep practical guides available for everyone.What to compare when evaluating a loan
A lower stated simple-interest rate by itself does not prove that a loan will cost less. To make a useful comparison, consider the measures and terms together:
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- Compare each loan’s APR with the other loan’s APR.
- Check whether interest is calculated on an outstanding balance or precomputed and allocated across payments.
- Compare the repayment term, payment schedule, and fees.
- Check how extra payments and early payoff are treated, including whether any unearned interest may be refunded.
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