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What is interest? (easy explanation) πŸ“ˆ

What is interest? (easy explanation) –

Introduction πŸ‘‹

Interest is a confusing word. Part of why it’s so confusing, is that interest can be both GOOD and BAD for your finances.

Disclaimer: This website provides information for guidance and educational purposes only. The Grown-Up School does not provide regulated financial advice. You can seek independent financial advice from a suitably qualified and regulated professional advisor. Check out our disclaimer policy for more information.

To explain “interest” in a simple way –

Interest is basically “extra money to say thank you

Interest = “extra money to say thank you” πŸ™

If you decided to lend a stranger Β£100 of your hard-won money, would you want them to pay you just Β£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 Β£100 back, instead you ask them to pay you Β£110 back – the Β£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. Β£100 in “extra money” to say thank you)

When you add money into your savings account, the bank might pay you interest (e.g. Β£15 in “extra money” to say thank you!) (Banks “borrow” your savings money off you).

Paying or earning? – Why interest is good AND bad πŸ‘πŸ‘Ž

You can either:

  • Earn interest from someone when you lend money (yay!πŸ™‚), 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 πŸ€“

To make the word “interest” even more confusing though, interest is usually shown as a percentage (%).

For example, if you borrowed Β£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 Β£100, you will need to pay Β£10 “extra money” to say thank you. In total you will need to pay us Β£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 Β£100 at 10% interest….

10% x Β£100 = Β£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 Β£100 you have to calculate 0.10 x Β£100. The answer is Β£10.

It can become quite easy to work interest out the more you practice!

Conclusion πŸ‘

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:

  1. Interest = extra money to say thank you
  2. You can earn interest by lending people money, you can also pay interest when you borrow money
  3. 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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