Non-blended loan
Non-blended loans are loans that use the simple interest calculation to determine monthly interest charges. Monthly payments for non-blended loans go down as their principal is paid off.
Non-blended loans require higher payments at the start of the amortization period than loans that have equal, unchanging monthly payments (called blended loans). Because of this, non-blended loans have a lower total interest cost than blended loans.
“Business owners often have a choice between getting a blended or non-blended loan, but it’s important to know that blended loans tend to cost more over the long term,” says Nigel Robertson, Senior Advisor, Client Retention at BDC.
“The reason has to do with how interest for each loan is calculated. Blended and non-blended loans are both reasonable choices depending on what you’re trying to maximize—lower total interest payments or more manageable initial monthly payments.”
If you can handle the slightly higher monthly payments at the outset of the amortization schedule, it’s worth considering a non-blended loan because the total interest cost is lower.
Nigel Robertson
Senior Advisor, Client Retention, BDC
What is non-blended or simple interest?
Non-blended or simple interest is a type of interest charge that sees steadily declining monthly loan payments as the principal is repaid. A loan that applies simple interest is commonly referred to as a non-blended loan. It also goes by several other names:
- principal + interest loan
- capital + interest loan
- straight-line linear loan
With a non-blended loan, principal repayment is the same each month. Meanwhile, interest payments decrease since there is less and less principal on which to pay interest after every principal payment.
This is in contrast to a blended loan (also known as a regular loan, a mortgage loan or an ordinary annuity). In a blended loan, the borrower pays the same monthly amount for the entire loan amortization period.
The payment amount for a blended loan is determined using a complex formula (called the mortgage formula) that calculates how much of each monthly payment goes toward principal and how much toward interest. At the beginning of the loan term, the interest portion of each payment is larger, and the principal portion increases as the loan matures.
“Your monthly payments never change, but what’s happening behind the scenes is that the payment is a mix of principal and interest blended into that single monthly payment,” Robertson says. “The proportions change every month.”
Non-blended loans have a lower total interest cost
Most lenders offer blended loans by default, though they might also give a non-blended loan when asked. For example, car loans, home mortgages and commercial loans from traditional lenders are typically blended loans.
The total interest paid over the life of a blended loan is higher because less money goes toward paying down the principal in the earlier months.
In non-blended loans, monthly payments are larger at the start and then decline until they become smaller than those for a blended loan.
Blended versus non-blended loans
| Blended loan | Non-blended loan | |
|---|---|---|
| Monthly payment | Never changes | Initially larger than for a blended loan, but becomes smaller about halfway through the amortization period |
| Principal portion | Smaller at the start, increases as the loan matures | Never changes |
| Interest portion | Declines as the loan matures | Declines more quickly than for a blended loan; the total interest paid is also lower |
“Blended loans are popular because the borrower knows exactly how much they’ll be paying every month,” Robertson says. “Also, the payments at the beginning of the loan, when many businesses are trying to conserve cash flow, are more affordable.”
However, Robertson explains that non-blended loans are actually more affordable than blended ones over the life of the loan.
“If you add up all the interest you’ve paid for a blended loan, it would be a bigger number than the interest paid on a non-blended loan at the same interest rate. That’s because in a non-blended loan you're returning more of the principal early on. The trade-off is the higher initial payments, which is why blended loans remain popular.”
(Being a development bank, BDC offers non-blended loans by default. This allows clients to reduce their total interest costs and keep more money in the business. BDC can offer blended loans on request, but certain products are only available as non-blended loans.)
Blended loans are popular because the borrower knows exactly how much they’ll be paying every month and the payments at the beginning of the loan are more affordable.
Nigel Robertson
Senior Advisor, Client Retention, BDC
How to select between a blended and non-blended loan?
Which is better for your business? “There are pros and cons,” Robertson says. “If you can handle the slightly higher monthly payments at the outset of the amortization schedule, it’s worth considering a non-blended loan because it keeps more money available to invest in your growth. Your business is likely earning a far higher return than the amount you pay in interest.
“A non-blended loan also allows you to pay down more of your loan from the start, which means you’re building equity more quickly and have a smaller lien against your assets.”
Example of a non-blended loan
The example below for ABC Co. shows the difference in interest costs between blended and non-blended (simple interest) loans.
An 8% non-blended loan of $1 million with a monthly principal payment of $3,335 costs $1,003,333 in interest over a 25-year amortization.
In comparison, an 8% blended loan costs $1,200,339 in interest over the same period.
In other words, the non-blended loan costs $117,005 less in interest—even though it has the same interest rate.
In fact, an 8% non-blended loan has the equivalent interest cost to a blended loan with a 6.38% interest rate (this is the non-blended loan’s “equivalent rate”).
The payment schedule for both loans shows how the monthly payments for the non-blended loan start off higher than those for the blended loan, but then eventually becomes lower at about the halfway point of the amortization period.
The first payment for the blended loan is a bit higher while all subsequent payments are of the same value.
ABC Co.
| Loan amount | $1,000,000 |
| Annual interest rate | 8% |
| Amortization years | 25 |
| Non-blended loan | Blended loan | |
|---|---|---|
| Total payments | $2,002,835 | $2,120,339 |
| Total interest | $1,002,835 | $1,200,339 |
| Initial payment | $10,001.67 | $7,718.16 |
| Final payment | $2,853.90 | $7,067.79 |
| Total interest saving | $117,005 | $0 |
Non-blended loan payment schedule
Blended loan payment schedule
What is the formula for simple interest?
For non-blended loans, monthly payments are calculated using what’s called the simple interest formula:
Monthly payments = Principal (Loan ÷ Number of periods) + Interest (Outstanding balance x (Interest rate ÷ 12))
For blended loans, monthly payments are calculated as follows using the mortgage (or annuity) formula:
M = Fixed monthly payment (a blend of both principal and interest into one fixed payment)
P = The original loan amount
r = The periodic (i.e. monthly) interest rate
n = The number of months in the loan. A 25-year loan, for example, has 300 months in it
How is the principal amount determined in a non-blended loan?
The monthly principal payments in a non-blended loan are determined by dividing the loan amount by the number of payment periods.
For example, in a $100,000 loan with a 10-year amortization, we divide $100,000 by 120 (the number of months) to arrive at monthly principal payments of $833.33.
Note that the principal paid is the same each month of the life of the loan unless the first month’s payment is adjusted to make the remaining payments a round number.
The first monthly payment could be $635 followed by 119 monthly payments of $835.
How does compounding affect blended vs non-blended loans?
Compounding is paying interest on interest. Loans compound either twice annually (i.e., every six months) or 12 times annually (every month). By law, blended fixed-rate loans in Canada compound twice annually. All other loans (i.e., blended variable-rate loans, fixed-rate non-blended loans and variable-rate non-blended loans) compound on a monthly basis.
Because of compounding, a loan’s nominal annual rate (the rate quoted by the lender) is not the actual rate paid over the year (the effective annual rate). Compounding frequency also affects the effective annual rate. For example, a 7% loan that compounds twice a year has an effective annual rate of 7.122%. If it compounds 12 times a year, the effective annual rate is 7.229%.
Compounding frequencies per year
| Blended loan | Non-blended loan | |
|---|---|---|
| Fixed-rate | 2 | 12 |
| Variable-rate | 12 | 12 |
Effective annual rate of a loan with a 7% nominal rate
| Blended loan | Non-blended loan | |
|---|---|---|
| Fixed-rate | 7.112% | 7.229% |
| Variable-rate | 7.229% | 7.229% |
“It might seem like a small difference, but when you spread it across 25 years, it starts to add up,” Robertson says. “It can be the reason for choosing a blended fixed-rate loan.”
The effective annual rate of a loan is calculated with the following formula:
Effective annual rate = (1 + (nominal rate ÷ number of compounding periods)) ^ number of compounding periods – 1
Next step
Get insights into what lenders and banks look for when evaluating you for a business loan by downloading the free BDC guide, How to Get a Business Loan.