What is interest? (easy explanation) –
Interest is a confusing word. Part of why it’s so confusing, is that interest can be both GOOD and BAD for your finances.
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To explain “interest” in a simple way –
Interest is basically “extra money to say thank you“
Interest = “extra money to say thank you” 🙏
If you decided to lend a stranger £100 of your hard-won money, would you want them to pay you just £100 back?
OR, would you want them to pay you a little bit extra to say thanks for the loan?
This is what interest is! – Interest is basically “extra money to say thank you for a loan”
Instead of the stranger giving you your £100 back, instead you ask them to pay you £110 back – the £10 is “interest“, to say thank you for the loan.
When you borrow money from a bank, you might have to pay them interest (e.g. £100 in “extra money” to say thank you)
When you add money into your savings account, the bank might pay you interest (e.g. £15 in “extra money” to say thank you!) (Banks “borrow” your savings money off you).
Paying or earning? – Why interest is good AND bad 👍👎
You can either:
- Earn interest from someone when you lend money (yay!🙂), or you can
- Pay interest to someone when you borrow money (nooo!☹️)
This makes interest both a GOOD thing and a BAD thing!
It’s great when you EARN loads of interest from your savings, but bad when you have to PAY loads of interest on a loan.
Hopefully that makes sense!
Interest as a percentage 🤓
To make the word “interest” even more confusing though, interest is usually shown as a percentage (%).
For example, if you borrowed £100 from a bank, they might tell you:
“You have to pay us 10% in interest” or “Our interest rate is 10%”
When it’d be SO much easier to understand if they said:
“If you borrow £100, you will need to pay £10 “extra money” to say thank you. In total you will need to pay us £110.”
This means that if you want to know what you’re paying/earning in real money numbers, you have to either ask the bank, or get your calculator out! ☹️
The way to work out the interest total is:
Interest you need to pay = interest rate x money you’re borrowing
So – if you were borrowing £100 at 10% interest….
10% x £100 = £10
To work this out on a calculator, all you need to do is move the percentage numbers after the decimal point.
For example, 10% is the same as 0.10, 15% is the same as 0.15.
So – to find out 10% of £100 you have to calculate 0.10 x £100. The answer is £10.
It can become quite easy to work interest out the more you practice!
If you’ve made it all the way to the end of this article, well done! Money can be a tricky subject to learn.
The 3 main things to remember about interest are:
- Interest = extra money to say thank you
- You can earn interest by lending people money, you can also pay interest when you borrow money
- Interest is usually shown as a percentage!
So that’s it! Hopefully you’re feeling more confident about understanding how interest works.
If you know any friends or family members who might benefit from learning about interest, share this post with them!
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