How Interest Works

Interest can feel like a mystery—especially when comparing a credit card to a personal loan. But once you see how the math works, you’ll understand why paying attention to how interest is calculated makes such a big difference in how fast your balance goes down.

Let’s break it down using the same example:$1,000 borrowed at 24% interest.

🔹 Credit Card Interest (Revolving Balance)

Credit cards use compound interest, meaning you’re charged interest on your balance and on any unpaid interest that rolls over each month.

If your credit card rate is 24% APR, that’s about 2% per month (24 ÷ 12).

• Starting balance: $1,000

• Interest for the first month: $20 (2% of $1,000)

• Minimum payment: $30

After you pay $30, only about $10 goes toward the principal—because $20 was interest. Next month, you’ll owe interest on roughly $990.

If you only pay the minimum, it will take 57 months to pay off that $1,000—and you’ll end up paying $664.42

in extra interest.

💬 Bottom line: Credit cards are convenient, but they’re designed to keep you paying longer.

🔹 Simple Interest Loan (Amortized)

Now let’s look at a 12-month simple interest loan for the same $1,000 at 24%.

With simple interest, your interest is calculated only on the remaining principal—not on prior interest.

Each payment covers part of the interest and part of the balance, so your payoff time and cost are fixed as long as you pay on time.

• Loan: $1,000 for 12 months

• Rate: 24% annual simple interest

• Payment: ≈ $94.55/month

• Total interest over the year: ≈ $134.60

✅ At the end of 12 months, you’re debt-free and have paid only about 13% more than you borrowed.

🔹 The “Rule of 78’s” Method

The Rule of 78’s (used in some older or short-term loans) front-loads interest—meaning you pay more of it in the early months.

It’s based on the sum of the months in the term: For a 12-month loan, 1+2+…+12 = 78.

Each month’s interest portion is weighted by its number. Month 1 gets 12/78 of the total interest, Month 2 gets 11/78, and so on.

If total interest on a $1,000, 12-month loan is about $134.60, the first payment includes roughly $20.71 in interest, while the last includes about $1.72.

💬 If you pay off early, you may save less than with a simple interest loan.

🔹 Paying Late: How It Affects Each Type

Here’s where timing really matters.

• Credit Cards: Late payments often trigger late fees and may increase your interest rate (known as a penalty APR). You’ll also accrue daily interest on the new, higher balance until it’s paid.

• Simple Interest Loans: Interest is calculated on the balance at the time of billing or payment. If you pay late, the lender continues to charge interest each day the balance remains unpaid. That means a late payment increases your total interest cost—even if your payment amount stays the same.

• Rule of 78’s Loans: Since the interest is pre-calculated at the start, a late payment usually adds only a late fee—not additional interest. The total interest on the loan doesn’t increase, because it was already determined when the contract began.

💬 In short: On a credit card or simple interest loan, time really is money. On a Rule of 78’s loan, time mostly just risks a late fee.

🔹 Comparing the Three

Loan Type	Payment	Time to Pay Off	Total Interest	Late Payment Impact	Notes
Credit Card (24%)	$30 minimum	~4+ years	$400+	Adds more interest daily, may trigger penalty rate	Interest compounds; balance barely moves
Simple Interest Loan (24%)	$94.55	12 months	$134.60	Late = extra daily interest	Fixed payoff if paid on time
Rule of 78’s Loan (24%)	$94.55	12 months	$134.60	Late = fee only; total interest unchanged	Front-loaded interest; less early payoff benefit

💬 The Takeaway

Interest isn’t “good” or “bad”—it’s simply the cost of borrowing, Knowing how it’s calculated and when it’s charged can save you a lot over time.

• Revolving credit compounds interest daily.

• Simple interest loans charge only on what’s owed—unless you pay late.

• Rule of 78’s loans are predictable but front-loaded.

At American First Financial Services, we believe in clear, fair, and simple lending—so you always know what you’re paying, when it’s due, and how to build your best credit story.

*Figures for comparison purposes only. Amounts to not include any annual fees, document fees, origination, etc.