Dawn of the Geeks

So when does a compound loan equal a simple interest loan?

Let’s say you borrow $150,000 and can afford a $1300 a month payment. The simple interest loan is 4%. The compound interest rate must be greater than 6.797644% or you’ll end up paying the same amount of interest and pay off the loans in the same amount of time. So a compound interest rate has to be nearly 2.8% higher than the simple interest loan or you’ll save money with the compound interest loan even though it has a higher interest rate.

If you can afford $1500 a month the compound rate has to be 6.959813% or higher or you’re better off with a compound interest loan.

Let’s try $1000 a month. Now the compound rate has to be 6.3629203% or higher or it’s a better deal than a 4% simple interest loan.

What you can see is that a simple interest loan is about equivelent to a compound interest loan that has an interest rate 2%-3% higher.

One of the claims of a simple interest loan is that you can pay it off in half the time without changing your payment. Let’s stick with a 4% simple interest loan on a $150,000 mortgage with a $1300 payment. It’s going to take about 188 months to pay off the simple interest loan. The interest on your compound interest loan would have to be more than 9.8% for that to be a true statement.

If we dropped the interest rate on the compound interest rate loan to 4% you’d pay it off in 146 months. More than 3 years earlier than the simple interest loan with the same rate.

We can see from this that it’s very difficult for a simple interest loan to save you money over a compound interest loan.

One last thing to consider is how much money you save in interest by increasing your monthly payment. We’ll start with a $1000 a month payment on a 150,000 loan. The interest rate for the simple interest is 4% and the interest rate for the compound interest is about 6.36% so both loans at $1000 a month cost you 150,000 in interest. Now let’s raise the payment $100.

You save $25,000 of simple interest. You save $33,000 in compound interest and pay off the loan 7 months earlier.

So you can see that putting extra money on a compound interest loan has a greater effect than putting extra money on a simple interest loan.

So you can see that unless you get a ridiculously low interest rate on a simple interest loan, it is very difficult to save money over a compound interest loan.