Many of us have heard or have encountered Interest when we get a financial deal or a loan in the bank. An Interest is a payment made by the borrower or a financial institution to a lender or a depositor. Meaning it’s a payment or a cost for using someone`s money. So, you pay or earn interest by borrowing or lending money.
For beginners, interest can be confusing and difficult to understand. Don`t fret, as even experienced investors tend to get confused about what interest is about. This article will discuss what interest is and how to calculate it.
Defining Interest
Interest is the percentage of a deposit or loan balance that is paid to the lender as a privilege or a benefit of using the borrowed money. Usually, interest is calculated as an annual rate. Though saying this, there are some Interests that can also be calculated for shorter or longer than one year.
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Interest is money added to the original loan balance that must be repaid depending on the deal`s duration period. So, to put it simply, in order for you to borrow money, you have to have more money to pay for it.
How Does It Work?
Interest can be calculated in various ways wherein some methods are more advantageous to lenders. What you`ll get in return would depend on the decision for paying interest. Also, earning interest depends on the various options available for investment.
For Borrowing Money: You will have to pay back the money you borrowed when asking for a loan. Also, You’ll have to repay more than what you initially borrowed to the lender to make up for the risk of lending and not being able to use the money they loaned to you.
For Lending Money: When you have extra money, you can lend the money to someone you trust or deposit it in your savings account to let the bank effectively invest the fund or lend it out. As a result, you’ll be able to earn interest. This way, you’ll not be tempted to spend the money but instead, save it by lending it while earning interest.
The amount you need to pay or earn depends on various factors. These factors include the total amount of the loan, the Interest Rate, and the duration of repayment for the loan. Always remember that if the loan has a high-interest rate or has a long duration for repayment, the borrower will end up paying more than usual.
Also, most banks and other financial institutions do not apply or use simple interest on loans. Instead, they use interest compounds which results in quick-growing interest amounts.
How to Earn Interest?
Interest can be earned by lending money or by depositing money into an interest-bearing bank account. These include a savings account or a certificate of deposit (CD). The purpose of the banks is that they’ll do the lending process for you by using your money for making investments and offering loans to their other customers. They will then give you the portion of the revenue they earned in the form of interest.
Depending on your bank, you will earn interest either every month, quarter, or a year from your savings. You’ll notice that there is an increase in your account balance which will be seen as interest payment on your transaction record. It is up to you whether to use and spend that interest or keep it on your account to keep it earning continually.
As a result, your savings will then gain momentum when you keep the interest in your savings account. This way, you’ll be able to gain interest on your initial deposit and also gain interest in your account.
Paying Interest
If you made a loan from your bank, you will need to pay that amount with added interest. Depending on your bank’s terms, there are various loans that have varied payment methods. These includes:
- Installment Debt: This kind of debt is common on student loans, auto loan, and standard home loans wherein the interest cost need to be monthly.
- Revolving Debt: Known as revolving loans, they allow you to loan month after month to make periodic payments on your loan.