Interest & Loans 101: How Does Interest Work on Loans?

Loans are helpful for those needing financial assistance, but they can also be intimidating, especially when paying back more than we borrowed. Knowing how loan interest functions is like having a map to confidently explore the world of finance.

When you borrow money through a loan, whether it’s a personal loan, mortgage, or credit card debt, you’re essentially obtaining funds from a lender. Lenders do not provide money without cost; they impose interest charges as compensation for permitting you to access their funds.

But how does interest on a loan work? How is interest calculated, and what factors affect it? At GoDay, we realize that a lack of information about interest rates can feel overwhelming. So, we promise a transparent borrowing process that enables you to make educated borrowing decisions. This blog will answer some of the most common questions about loan interest rates in Canada. 

The Basics of Interest 

Interest represents the expense associated with obtaining a loan. When you acquire a loan, you’re essentially receiving borrowed funds, and in return, you commit to reimbursing the principal amount (the initial sum borrowed) plus an extra sum, which constitutes the loan’s interest. Interest serves as the lender’s remuneration for extending the loan, usually denoted as a percentage of the principal amount.

Simple Interest vs. Compound Interest 

To better understand how does interest on a loan work, it’s important to distinguish between two main types of interest: simple and compound. 

Simple Interest

In this method, interest is calculated only on the principal amount. It remains constant throughout the loan term. For example, if you borrow $1,000 at a 5% simple interest rate for one year, you’ll pay $50 in interest ($1,000 x 0.05). 

Compound Interest

This is where things get more complex. Compound interest is calculated on the principal amount and any accumulated interest from previous periods. It can significantly affect the total amount you repay over time. Most loans, such as mortgages and credit cards, use compound interest.

Once you understand the difference between simple vs. compound interest, taking out a loan that works in your best interests will be easier. GoDay offers the best online payday loans with a streamlined application process. Reach out to our customer service team for more information. 

How to Calculate Interest Rate on a Loan?

One of the most common questions when learning about interest rates is how to calculate interest rate on a loan?

Finding the interest rate of a loan becomes uncomplicated once you comprehend the fundamental formula. The most prevalent method for this computation involves employing the simple interest formula.

To calculate the interest on a loan, you’ll need three key pieces of information:

  • The principal amount (the amount you borrowed).
  • The interest rate (expressed as a percentage).
  • The time period (how long you will be borrowing the money). 

The formula for calculating simple interest on loan is: Interest = Principal x Rate x Time. 

Keep in mind that this is a simplified formula example. Different loans may have other interest structures, such as compound interest, which considers the accumulated interest over time. Even if you need to get money quickly, you must understand how interest on a loan works before proceeding. 

For a basic understanding, the simple interest formula should do the trick! Always check the terms and conditions of your specific loan agreement, as additional factors or fees may affect the interest calculation.

Factors Influencing Interest Rates

After you better understand how loans work you can delve deeper into interest rates. Interest rates aren’t arbitrary numbers set by lenders. A variety of factors influences them.

Credit Score

Your credit score can play a significant role in the interest rate lenders charge. A higher credit score tells lenders that you are a responsible borrower, resulting in lower interest rates. However, at GoDay, we don’t focus solely on credit scores. We offer bad credit loans to individuals in quick need of cash. We request that you complete a short application online to determine your eligibility for a loan from our website. 

Loan Term

The length of your loan term can affect the interest rate. The interest on short-term loans is typically lower, while longer-term loans have higher rates. 

Economic Conditions

Interest rates are also influenced by broader economic conditions. When the economy is thriving, interest rates may rise. Conversely, during economic downturns, they tend to decrease. It’s important that you look into current loan interest rates in Canada to ensure how much borrowing can cost you based on the economic conditions.

Type of Loan

The type of loan you’re applying for matters too. Mortgages generally have lower interest rates than personal loans or credit cards because your home secures them.

The Mechanics of Loan Amortization 

Understanding how interest works on loans also involves grasping the concept of loan amortization. Amortization refers to paying off a loan through regular, equal payments over its term. These payments typically include principal and interest, but the proportion of each changes over time. 

When you understand how to calculate interest on a loan, you’ll observe that at the beginning of a loan, a larger share of your payment is directed towards interest, and a smaller portion goes towards diminishing the principal. However, as you persist in making payments over time, this distribution evolves. A greater part of your payment is directed towards the principal, thereby decreasing the total interest expense.

To visualize this, consider a 30-year mortgage. In the early years, interest is a significant chunk of your monthly payment. As the years pass, a more significant portion goes toward paying down the principal, helping you build equity in your home.

On the other hand, installment loan interest rates in Canada vary as these loans don’t last as long as a mortgage. You can borrow anywhere from $1,000 to $15,000 when you choose GoDay’s online installment loans. Our flexible terms allow you to repay your loan in affordable fixed payments that fit your budget. 

The Impact of Interest on Your Finances 

Now that we’ve covered the fundamentals of loan interest let’s explore its real-world implications. 

The Cost of Borrowing 

Interest can significantly increase the overall cost of borrowing. For instance, on a 30-year mortgage, you may pay almost as much (if not more) in interest as the original loan amount. This underscores the importance of shopping around for the best interest rates and considering shorter loan terms if possible. The interest on small loans will be lower, reducing your overall cost of borrowing. 

The Power of Early Repayment 

To decrease the interest you’re responsible for on a loan, you can opt for strategies like making supplementary payments or settling the loan ahead of schedule. When you make extra payments, you expedite the reduction of the principal balance, consequently diminishing the overall interest paid throughout the loan’s duration.

But it’s essential that you talk to the lender to confirm their policies on repaying a loan before the date you initially agreed upon. Some lenders may have a prepayment penalty for breaking the contract. 

The key to avoiding unexpected payments is being cautious when filling out loan applications and choosing a reputable lender like GoDay that offers a transparent borrowing process. We ensure that there are no surprises at any point throughout the process. 


Interest on a loan is a financial concept that impacts nearly everyone at some point. Understanding how it works and getting familiar with current loan interest rates can help you make informed borrowing decisions, from choosing the right type of loan to negotiating favourable interest rates. 

Think of interest like a double-edged sword. It can either help you or hurt you, depending on what you do with your money. So, the next time you want to get a cash loan, you’ll know how interest works, how to figure out the interest on a loan, and how it can affect your financial health.