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Making a Partial Payment on a Simple Interest Loan

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Partial Payments for a Simple Interest Loan
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Partial Payment

D. Russell
I am often asked how to calculate the partial payment on a simple interest loan and if in fact it is worth making a partial payment on a loan. First of all, check with your bank about the rules. They can vary depending upon the country you live in or with the holder of the loan. Typically, a lump sum payment would be paid on the maturity date of the loan. However, borrowers may wish to save some interest and make one or more partial payments before the maturity date when the loan comes due. Typically, what often happens, is the partial loan payment is applied to the accumulated interest. THEN, the remainder of the partial payment is then applied to the principal of the loan. This is actually referred to as the US Rule which states: any partial loan payment first covers any interest that has accumulated. The remainder of the partial payment reduces the loan principal. This is why it is extremely important to check the rules with your lender. In many cases, legislation exists that forbids the lender from charging interest on interest.

Before providing you with the steps to calculating partial payments and understanding the savings, it is important to understand a couple of key terms:
1.) Adjusted Principal: this is the principal that remains after the partial payment(s) has been applied to the loan.
2.) Adjusted Balance: This is the remaining balance due on the maturity date after a partial payment(s) has been made.

The Process (as shown above) 1. Find out the exact time from the day of the initial loan to the first partial payment.
2. Calculate the interest from the exact time of the loan to the first partial payment.
3. Subtract the interest dollar amount in previous step from the partial payment.
4. Subtract the remainder of the partial payment from step above from the original amount of principal which will give you the adjusted principal.
5. Repeat this process for any additional partial payments. 6. At maturity, you will then calculate the interest from the last partial payment. Add this interest to your adjusted principal from the last partial payment. This is provide you with the adjusted balance that is due on your maturity date.

Now for a real life example:

Deb borrowed $8000. at 5% for 180 days. On the 90th day, she will make a partial payment of $2500. Example 1 shows you the calculation to arrive at the adjusted balance due on the maturity date.

Example 2 Shows you the calculation for the interest saved by making the partial payment. (see next)

You may also find this article on calculating the exact number of days for a loan quite helpful.

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