Two lenders can quote you the same “6%” and charge you very different amounts, because the rate is only half the story — the other half is the method used to apply it. Business loans compute interest four main ways: on the shrinking balance of an amortizing loan, as simple interest on the original principal, as a factor rate fixed at funding, or on the average daily balance of a line of credit. This page walks through each method with one worked example, so you can tell which machine is running inside any quote you receive. To see what the methods do to a monthly payment, use the business loan calculator.
General information, not financial advice.
This is the standard structure for bank and SBA term loans. Interest is charged each period on the balance you actually owe at that moment — not on the amount you originally borrowed. Because the balance falls with every payment, the interest portion of each payment falls too, even though the payment itself stays level.
Worked example. Borrow $50,000 at 6% APR. The monthly rate is 6% ÷ 12 = 0.5%, so the first month’s interest is $50,000 × 0.005 = $250. After your first payment reduces the balance, the second month’s interest is computed on that smaller balance, and so on down to zero. This is why extra principal payments save real money under this method: every dollar of principal you remove early stops accruing interest for the rest of the term.
Some short-term and equipment products use the textbook simple-interest formula instead:
Interest = Principal × Rate × Time (I = P × R × T)
Worked example. Using the US Chamber of Commerce’s example: $50,000 × 6% × 1 year = $3,000 of interest. The total is fixed at the start and divided into equal payments. The critical difference from method 1: the interest is computed on the original principal for the whole term, regardless of how much you have already repaid. Paying extra principal mid-term does not reduce the total on a precomputed loan like this, because the interest was never tied to your current balance.
Merchant cash advances and many short-term online products are priced with a factor rate — a multiplier, typically quoted between 1.1 and 1.5 — instead of an interest rate. The arithmetic is deliberately simple: multiply the amount funded by the factor to get the total repayment.
Worked example. $50,000 funded at a factor rate of 1.25 means you repay $50,000 × 1.25 = $62,500, a fixed cost of $12,500. The total is set at funding and does not shrink if you repay early — there is no balance for interest to ride on. A factor rate also carries no time dimension, so it cannot be compared with an APR directly; a 1.25 factor repaid over 6 months costs far more per year than the same factor repaid over 18 months. The working capital loan calculator models factor-rate loans alongside APR loans so you can see both shapes.
A business line of credit charges interest only on what you have drawn, computed from your daily balances. The lender converts the APR to a daily rate (APR ÷ 365), applies it to each day’s balance, and bills the accumulated total for the period.
Worked example. Using Lendio’s published example: a $10,000 balance at 12% APR accrues 12% ÷ 365 ≈ 0.0329% per day, which is about $3.29 per day, or roughly $98–99 over a 30-day month. Draw more and the daily charge rises immediately; repay and it falls the same day. This responsiveness is the line of credit’s main advantage — and the reason its interest is the hardest of the four methods to predict in advance.
| Method | Interest rides on | Rewards early repayment? | Typical products |
|---|---|---|---|
| Amortizing | The current outstanding balance | Yes — interest falls as balance falls | Bank and SBA term loans |
| Simple (precomputed) | The original principal, whole term | No — total fixed at signing | Some short-term and equipment products |
| Factor rate | Nothing — total fixed at funding | No — total fixed at funding | MCAs, short-term online loans |
| Average daily balance | Each day’s drawn balance | Yes — immediately, day by day | Lines of credit |
The quote documents tell you which method applies: look for an amortization schedule (method 1), a stated total repayment or factor (method 3), or daily-balance language in the line agreement (method 4). If a product’s true cost still isn’t clear, fees matter as much as the rate — the business loan APR calculator folds fees into the rate so products can be compared honestly. For the cost verdict on simple interest versus amortizing loans specifically, see simple interest vs amortizing loans.
How is interest charged on a business loan? It depends on the structure. On a standard amortizing loan, interest is charged each period on the outstanding balance — the first month on $50,000 at 6% APR is $250, and the charge shrinks as the balance falls. Precomputed simple-interest products charge on the original principal for the full term instead; factor-rate products fix the total cost at funding; lines of credit charge on each day’s drawn balance.
What is the difference between simple interest and compound interest? Simple interest is computed only on the principal: I = P × R × T (Patriot Software’s explainer uses the same formula). Compound interest is computed on principal plus interest already accrued, so the base grows over time. Most amortizing business loans sit between the two in practice: interest is charged monthly on the remaining balance, but because you pay that interest off each month, it does not compound against you the way an unpaid credit balance does.
How is interest calculated on a line of credit? By the average daily balance method: the lender divides the APR by 365 to get a daily rate and applies it to each day’s outstanding balance, billing the accumulated total (Lendio’s line-of-credit guide works this method). At 12% APR, a steady $10,000 balance costs about $3.29 a day — roughly $98–99 a month — and the charge moves up or down the day your balance changes.
Sources: US Chamber of Commerce, “How Interest Is Charged on a Business Loan” (simple-interest formula and worked example); Patriot Software, simple vs compound interest explainer; Lendio, business line of credit guide (average daily balance method and example); Xero, loan interest guide (reducing-balance framing). Currency verified 2026-10-23.