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Interest on loans


On all loans it is almost always a fee, this fee paid on borrowed capital is called interest. Interest is calculated upon value of assets, and can be thought of as rent on money.

Interest is a compensation to the lender that relates to the cost of borrowing money. It is the price that a lender charges a borrower for the use of the lender’s money. This cost is often looked upon as lost rate of profit.

There are many types of interest, but the most common ones are simple interest and compound interest, and rates is usually either fixed or floating. Simple interest is calculated only on the principal (principal is the original amount of a debt on which interest is calculated), or of the principal which remains unpaid. It is calculated according to the formula I = ( r * B ) * n  (where r is the period interest rate, B is balance, n is number of time periods).

Compound interest is similar to simple interest, but as time goes the difference becomes lager. The conceptual difference is that the principal changes with every time period. Put another way, the lender is charging interest on the interest. I = B * (( 1 + r )^n – 1)

Loans generally use compound interest, but they may not always have the same singe interest rate over the life of the loan. Loans that have a changeable rate over the life of the loan are loans with a floating rate. Whereas a loan where the interest rate does not change are referred to as fixed rate loans.

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