Interest is the cost of borrowing money, charged by the lender as a percentage of the amount owed. It is the amount paid on top of repaying the principal.
Interest is what a lender charges for the use of borrowed money, expressed as a rate applied to the outstanding balance. On an installment loan, interest is built into each scheduled payment alongside principal, and because interest is generally calculated on the remaining balance, the interest share of each payment tends to decline as the loan is paid down. Interest can be charged at a fixed rate that stays the same or a variable rate that can change over time. The interest rate is distinct from the annual percentage rate (APR), which also reflects certain required fees. Paying a loan off ahead of schedule can reduce the total interest, depending on how interest accrues and whether a prepayment penalty applies.
Interest is usually stated as a rate for a period of time, and the dollars it produces depend on three things: the rate, the balance it applies to and how long that balance is outstanding. That is why a smaller loan, or one repaid sooner, generally costs less interest, even at the same rate.
Lenders calculate interest in different ways. Simple interest is charged only on the principal balance, while compound interest is also charged on interest that has been added to the balance. On amortizing installment loans, interest is typically computed on the remaining principal, so the interest portion of each payment shrinks as the loan is paid down.
Interest also depends on how the lender counts time. Some loans accrue interest daily on the outstanding balance, so a payment made a few days early reduces the interest slightly, while a late payment increases it. Others calculate interest on a fixed schedule regardless of the exact payment date. The agreement explains which method applies.
An example
Two borrowers take out the same loan at the same rate. One follows the schedule exactly; the other makes an extra payment partway through. Because interest is charged on the remaining balance, the second borrower's balance is lower for the rest of the loan, and the total interest paid ends up smaller, provided the agreement has no prepayment penalty.
Common misconceptions
Myth: Interest and the total cost of credit are the same thing.
In fact: Interest is the charge for using the principal. The full cost of credit can also include required charges, which federal disclosures combine with interest into a single finance charge.
Myth: Paying early never changes the interest owed.
In fact: When interest accrues on the remaining balance, paying the balance down sooner reduces the interest that would otherwise have accrued.
Myth: The same rate always produces the same interest.
In fact: The dollars of interest also depend on the balance and on how long it is outstanding, so two loans at one rate can cost very different amounts.
What to check
- Whether the rate is fixed or can change.
- Whether interest is simple or compounding, and on which balance it is charged.
- The finance charge in dollars, not just the rate.
- Whether paying early reduces the interest owed.
How this applies at Desert Rock Capital
Interest on a Desert Rock Capital loan accrues on every dollar you borrow, which is why borrowing only what you need keeps the schedule lighter. There is no prepayment penalty, so if you clear the balance early, you only pay interest for the time you had the loan. The amount, each biweekly payment and the total cost are disclosed in writing before you sign.
Based on our loan requirements, loan amounts and application pages. Your actual terms are in the loan agreement.