Simple Interest Loan vs Amortized Loan: Which is Better for Your Business?

When seeking financing for your small business, two of the most common loan structures you’ll encounter are simple interest loans and amortized loans. Both loan types have fixed interest rates and regular payment schedules. However, they calculate interest and principal repayment differently.

Understanding how simple interest loans compare to amortized loans is crucial when weighing financing options for your company. This comprehensive guide examines the key distinctions between the two loan structures. We’ll also discuss the pros, cons, use cases, and eligibility requirements to help you determine if a simple interest or amortized loan is more suitable for your situation.

What is a Simple Interest Loan?

With a simple interest loan, the interest is calculated only on the original loan principal. The interest is determined upfront and charged for the entire loan term on day one.

The total interest for the full loan duration gets divided by the number of payment periods to calculate your fixed periodic payment amount. A portion of each payment goes towards interest, and a portion goes towards principal in equal amounts.

For example:

• You take out a 12-month simple interest loan for $100,000 at 10% interest
• The total interest owed would be $100,000 x 0.10 = $10,000
• Dividing this by 12 months, your monthly fixed payment is $8,333.33
• Each payment, $833.33 would go towards interest and $7,500 towards principal

The main benefit of simple interest loans is they have predictable, even payments. The drawback is that you can’t save on interest costs by paying off the loan early.

What is an Amortized Loan?

Amortized loans have payments that pay down both principal and interest. But the allocation between principal repayment and interest differs with each payment

With amortized loans, the interest accrues based on the remaining principal balance each period. So as the balance decreases, less interest is owed. More of each payment gets applied to principal over time.

For example:

• A 5-year $100,000 loan at 10% interest
• The monthly payment would be $2,024.35
• The first payment:
  • $833.33 goes to interest
  • $1,191.02 goes to principal
• By the final payment:
  • $69.17 goes to interest
  • $1,955.18 goes to principal

Amortization allows you to pay less interest over the loan term by making extra principal payments. A drawback is amortized loans usually have stricter eligibility requirements.

Key Differences Between Simple Interest and Amortized Loans

Pros and Cons of Simple Interest Loans

Pros:

• Lower total interest costs for shorter terms
• Predictable, even payments
• Faster funding times
• More lenient eligibility
• Typically don’t require collateral

Cons:

• Limited terms up to 2 years
• No way to pay less interest
• Higher payments could impact cash flow
• Might have prepayment penalties
• Higher rates than amortized loans

Pros and Cons of Amortized Loans

Pros:

• Lower rates and payments than simple interest
• Longer terms up to 10+ years
• Pay extra principal to reduce interest
• Access larger loan amounts

Cons:

• More total interest paid over full term
• Tougher to qualify
• Usually requires collateral
• Longer funding times than simple interest

Which Loan Structure is Better for Your Business?

There’s no definitively “better” option. It depends on your specific funding needs and business situation.

Simple interest loans are better if:

• You need short-term working capital
• Your business is newer or doesn’t qualify for amortized loans yet
• You need faster funding and can afford higher payments
• You don’t require a large loan amount

Amortized loans are better if:

• You need a larger loan amount for long-term investments
• You want to pay off the loan ahead of schedule to reduce interest
• Your business is established and likely to qualify
• You want lower interest rates and payments

For medium business goals 3-5 years out, either loan type could potentially work. Evaluate your budget, cash flow, operations and eligibility to decide if simple interest or amortization better matches your financing needs.

Where to Find Simple Interest and Amortized Business Loans

Both simple interest and amortized loans are offered by traditional lenders like banks and credit unions as well as online alternative lenders.

Banks primarily only offer amortized loans. Alternative lenders are more likely to offer simple interest loans in addition to amortized financing.

An easy way to compare multiple lenders and loans customized for your business is to use an online lending marketplace. Marketplaces like BusinessLoan.com let you complete one form to receive offers from their network of lenders.

Key Takeaways

• Simple interest loans charge fixed interest upfront on the original principal. Amortized loans charge interest on the remaining principal balance each period.

• Simple interest loans have higher, equal payments. Amortized loans have payments skewed more heavily towards principal over time.

• Simple interest loans provide faster funding but no savings for early repayment. Amortized loans take longer to fund but allow you to pay less interest.

• Newer businesses tend to qualify more easily for simple interest loans. Established businesses often qualify for lower-rate amortized loans.

• Assess your specific funding needs, eligibility, and budget to decide if simple interest or amortized loans are more suitable.

Understanding the difference between simple interest vs amortized loans allows you to make an informed decision when financing your business. Be sure to consider all your options to find the loan structure providing the right loan amount, term length, and payment amount to support your goals.