Two Types of Interest
Simple Interest
Calculated only on the original principal.
Formula: Interest = Principal × Rate × Time
$10,000 loan at 5% for 3 years:
- Interest = $10,000 × 0.05 × 3 = $1,500
- Total repayment: $11,500
Common in: Auto loans, some personal loans
Compound Interest
Calculated on principal plus accumulated interest.
$10,000 at 5% compounded annually for 3 years:
- Year 1: $10,000 × 1.05 = $10,500
- Year 2: $10,500 × 1.05 = $11,025
- Year 3: $11,025 × 1.05 = $11,576
- Total interest: $1,576 ($76 more than simple)
Common in: Credit cards, mortgages, savings accounts
The longer the loan and higher the rate, the bigger the gap between simple and compound interest.
APR vs APY: What's the Difference?
| Term | What It Is | When Used |
|---|---|---|
| APR | Annual Percentage Rate — doesn't include compounding | Loans (what you pay) |
| APY | Annual Percentage Yield — includes compounding | Savings (what you earn) |
A credit card with 24% APR compounded monthly has an effective APY of 26.82%. The APR undersells the true cost.
How Mortgage Interest Works
Mortgages use amortization — your payment stays the same, but the split between principal and interest shifts over time.
Early in a 30-year mortgage, most of your payment goes to interest:
| Year | Principal % | Interest % |
|---|---|---|
| 1 | 22% | 78% |
| 5 | 27% | 73% |
| 10 | 35% | 65% |
| 15 | 46% | 54% |
| 20 | 62% | 38% |
| 25 | 81% | 19% |
This is why extra payments in the early years have the biggest impact.
How Credit Card Interest Works
Credit cards compound daily. Here's how:
- Your APR (e.g., 24%) is divided by 365 = daily rate (0.0657%)
- Each day, your balance × daily rate = daily interest
- This interest is added to your balance
- Tomorrow, you pay interest on the larger balance
$5,000 balance at 24% APR with minimum payments:
- Monthly interest: ~$100
- Minimum payment: ~$125
- Only $25 goes to principal!
5 Ways to Pay Less Interest
1. Make Extra Payments
Even $50 extra per month on a mortgage saves thousands. The extra goes directly to principal, reducing future interest.
2. Pay Biweekly Instead of Monthly
Making half your monthly payment every 2 weeks = 26 half-payments = 13 full payments per year instead of 12. This can shave years off your mortgage.
3. Refinance When Rates Drop
A 1% rate reduction on a $300,000 mortgage saves ~$60,000 in interest over 30 years.
4. Choose Shorter Loan Terms
15-year mortgages have lower rates AND less time for interest to accumulate.
5. Pay Credit Cards in Full
If you pay your credit card balance in full each month, you pay $0 in interest. The grace period means no interest on new purchases if your balance is paid.
Calculate Your Loan Costs
Use our [loan calculator](/loan-calculator) to see exactly how much interest you'll pay on any loan, or our [mortgage calculator](/mortgage-calculator) to view a full amortization schedule.