Interest is an interesting word! Interest is one of those words in
the English language that has more than one meaning. Do you remember
your English grammar and know the difference between a verb and a
noun? When you are interested in learning something, interest is a
verb. But when you are learning about interest in math class, interest
is a noun.
Interest is the money you pay for borrowing money; you must pay back
what you borrowed plus the amount of interest. When you save money
in the bank, interest is money that the bank pays you. When you take
out or withdraw the money you get what you put in plus interest.
The interest rate determines the amount of interest that you pay
or get. Interest rates are usually shown as a percent. If you borrowed
$100 at 3% interest, how much would you owe?
Calculate the interest: $100 x 3% = $100 x 0.03 =
Amount to repay: $100 + interest = $100 + $3 = $103
Now that you understand how interest is calculated and what an interest
rate is, let's look at why interest rates are important in your life.
1. Interest makes money
When you save money in the bank, you make money because you earn
interest. The higher the interest rate, the more money you can make.
It makes sense to shop for higher interest rates.
2. Interest compounds
This means that if you leave your money in the bank, you earn interest
on the interest you get. This means you earn even more money. In the
example, the next time interest is added to the savings account, it
will be 3% of $103 not the $100 you put in the bank.
3. Rule of 72 The
Rule of 72 gives you an idea of how long it will take for the compounded
interest to double the amount of money you started with. It's very
simple; you just divide 72 by the interest rate as a number. 72 /
3 = 24 After 24 years you would have $200.
4. Higher rates make a difference in saving
What if you found a higher interest rate, say 6%? Your money would
double in just 12 years.
5. Interest in borrowing
When you borrow money, you must pay the interest. If you are making
monthly payments, this is called an installment loan. Part of your
monthly payment pays back money you borrowed and part pays the interest.
So if you borrowed $100 at 3% and made 4 payments of $10 each ($40),
you would still owe more than $60 because of interest.
6. Higher rates make a difference in borrowing
If you borrowed the $100 at 6%, how much would you owe? $106. A higher
interest rate in borrowing means that you pay more money in interest.
You usually want to shop for the lowest interest rate when you borrow
7. Interest rate is per year
This is very, very important to remember! The amount of interest
you get in a savings account will compound every year like we talked
about before. What happens when you borrow money? Let's say that you
didn't pay any money in the first year on the loan for $100 with a
rate of 6%. How much do you owe at the end of the year? $106. Now
you are paying interest on the interest and it costs you more money.
8. Credit card interest is very high
When you understand about interest rates, you understand that high
interest rates can cost you a lot of money. Credit card companies
charge high interest rates, like 20%, if you don't pay your entire
amount when the bill comes. It's called a credit card because credit
is another term for borrowing money. If you leave a $100 amount on
your credit card bill for a year, it costs you a whopping $20 in interest!
9. Credit card debt is a big problem
There are lots of commercials on TV about getting out of the problem
of too much credit card debt. If you really understand interest rates
and know what interest rate your credit card company charges, you
will see that keeping your credit card paid off is a smart thing to
do. Credit card interest is very expensive and can get you into trouble.
10. Read the contract
When you start a savings account and especially when you borrow money,
be sure to read and understand all the papers that come with the contract.
Be sure that you read carefully about the interest rate, especially
the rate on a credit card.