What Is Interest?

Interest is the cost of using someone else's money. When you borrow money, you pay interest. When you borrow money, you earn interest.

Here, you will learn more about interest, including what it is and how to calculate how much you earn or owe, depending on whether you borrow or borrow.

What is interest?

Interest is calculated as a percentage of the balance on a loan (or deposit), which is paid to the lender periodically for the privilege of using your money.

The amount is generally quoted as an annual rate, but interest can be calculated for periods greater or less than one year.

Interest is additional money that must be repaid beyond the original balance of the loan or deposit. In other words, consider the question: What does it take to borrow money? The answer: more money.

How does interest work?

There are several ways to calculate interest, and some methods are more beneficial to lenders. The decision to pay interest depends on what you get in return, and the decision to earn interest depends on the alternative options available to invest your money.

Borrowing: To borrow money, you will need to repay what you borrowed. Also, to compensate the lender for the risk of lending to you (and for your inability to use the money elsewhere while using it), you must repay more than you borrowed.

Borrowing: If you have extra money available, you can either borrow it yourself or deposit the funds into a savings account, allowing the bank to lend or invest the funds to you. In return, you expect to earn interest. If you're not going to earn anything, you may be tempted to spend the money instead, because there is little point in waiting.

How much do you pay or earn in interest?

It depends on:

The interest rate
The loan amount
How long does it take to pay

A higher rate or a longer-term loan makes the borrower pay more.

Example: An interest rate of 5% per year and a balance of $ 100 results in interest rates of $ 5 per year, assuming you use simple interest. To see the calculation, use the Google Sheets spreadsheet with this example. Change the three factors listed above to see how the cost of interest changes.

Most banks and credit card issuers do not use simple interest. Instead, interest increases, resulting in interest amounts that grow faster.

How do I earn interest?

You earn interest when you borrow money or deposit funds into an interest-bearing bank account, such as a savings account or a certificate of deposit (CD).

Banks make the loans for you: they use your money to offer loans to other customers and make other investments, and they transfer a part of that income to you in the form of interest.

Periodically (every month or quarter, for example) the bank pays interest on your savings. You will see an interest payment transaction and notice that your account balance increases.

You can either spend this money or keep it in your account so that it continues to earn interest. Your savings can really gain momentum when you leave interest on your account; You will earn interest on your original deposit, as well as interest added to your account.

Earning interest in addition to previously earned interest is known as compound interest.

When do I have to pay interest?

When you borrow money, you usually have to pay interest. But this may not be obvious, as there is not always a separate line item or invoice transaction for interest costs.

Installment debt: With loans like standard home, auto, and student loans, interest costs are included in your monthly payment.

Each month, part of your payment goes towards debt relief, but another part is the cost of interest. With these loans, you pay off your debt for a specified period of time (a 15-year mortgage or a five-year car loan, for example).

Revolving Debt - Other loans are revolving loans, which means you can borrow more month after month and make regular debt payments.

For example, credit cards allow you to spend repeatedly as long as you stay below your credit limit. Interest calculations vary, but it is not too difficult to determine how interest is charged and how your payments work.

Additional costs: Loans are generally priced at an annual percentage rate (APR). This number tells you how much you pay per year and may include additional costs in addition to interest rates. Your pure interest cost is the interest rate (not the APR).

With some loans, you pay closing or financing costs, which are not technically interest costs derived from the value of your loan and its interest rate. It would be helpful to figure out the difference between an interest rate and an APR. For comparison purposes, an APR is usually a better tool.

We hope you enjoy watching this video about what is interest

Source: Not In School


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