What is the difference between simple and compound interest?

Simple interest is charged only on the original principal. Compound interest is charged on the principal plus the interest that has already accrued, so the balance grows faster. Most private promissory notes use simple interest because it is easier to track and harder to challenge; compounding can also run into usury limits faster.

How do I calculate simple interest?

Use Interest = Principal x Rate x Time. For a $10,000 loan at 6 percent for one year, that is 10,000 x 0.06 x 1 = $600. For partial years, express time as a fraction (6 months is 0.5). For a daily figure, divide the annual interest by 365 to get the per diem.

What is a per diem and why does it matter?

The per diem is the daily interest amount: annual interest divided by 365 (some notes use 360). It matters at payoff, because the final amount owed is the remaining principal plus interest accrued to the exact payoff date. Stating the per diem in the note removes any argument about the last few days.

What is the difference between the interest rate and the APR?

The nominal rate is the stated annual rate. The APR (annual percentage rate) reflects the rate plus certain fees and the effect of compounding, so it shows the true yearly cost. Two notes with the same nominal rate can have different APRs if one compounds more often or charges fees.

Can interest plus late fees push me over the usury cap?

Yes. Many states count late fees and default interest toward the effective rate when deciding whether a loan is usurious. A note that looks compliant on its base rate can become usurious once penalties are added. Always check your state cap against the all-in effective rate, not just the stated rate.

How to Calculate Interest on a Promissory Note

A promissory note is only as clear as its math. If the borrower and lender cannot agree on how much is owed on a given day, the note has failed at its one job. This guide walks through simple and compound interest, how accrual and amortization work, and how to keep the all-in rate under your state's usury cap.

Simple interest: the formula most notes use

Simple interest is charged only on the original principal. The formula is:

Interest = Principal x Rate x Time

On a $10,000 loan at 6 percent annual interest for one year: 10,000 x 0.06 x 1 = $600. For half a year, time is 0.5, so the interest is $300. Simple interest is the default for most private notes because it is transparent and easy to verify.

The per diem (daily interest)

For payoffs, partial months, and late periods, you need the daily figure. Divide the annual interest by 365 (some notes use a 360-day year, so state which in the note):

Per diem = (Principal x Rate) / 365

On the $10,000 note at 6 percent, that is 600 / 365 = about $1.64 per day. At payoff, the borrower owes the remaining principal plus the per diem times the number of days since the last payment. Putting the per diem in the note ends arguments about the final days.

Compound interest

Compound interest charges interest on the principal plus interest already accrued. It grows faster than simple interest, and the more often it compounds (annually, monthly, daily), the faster it grows. The general formula for a balance with no payments is:

Balance = Principal x (1 + r/n) raised to the power (n x t), where r is the annual rate, n is the number of compounding periods per year, and t is years.

Compounding can push the effective rate higher than the stated rate, which matters for usury. Many private lenders choose simple interest specifically to avoid that complication.

Amortized notes: where each payment goes

An amortized note has a fixed periodic payment that covers interest first, then principal. Early payments are mostly interest; later payments are mostly principal. Each period:

Interest for the period = current balance x (annual rate / payments per year)
Principal portion = payment minus that interest
New balance = old balance minus the principal portion

An amortization schedule lists every payment this way until the balance reaches zero. It is the cleanest structure for a fully repaid installment loan.

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Nominal rate vs APR

The nominal rate is the rate written on the note. The APR reflects that rate plus certain fees and the effect of compounding, so it represents the true annual cost. Two notes can quote the same nominal rate but carry different APRs if one compounds more often or adds fees. When comparing or disclosing cost, the APR is the honest number.

Late fees and default interest

Many notes raise the interest rate after default or add a late fee. Both increase what the borrower owes, and both can count toward the effective rate for usury purposes. Keep them modest and tied to actual harm. For the mechanics, see our guide on late fees, default interest, and grace periods.

The usury ceiling on all of it

No matter how you calculate interest, it has to stay under your state's legal maximum. Many states count fees and default interest toward that cap, so a note that looks fine on its base rate can become usurious once penalties are added. Check the all-in effective rate against your state limit before you set the terms. Our Usury Limit Checker shows the cap by state.

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