Interest is the cost you have when you borrow money. By the same token, if you lend money, you can earn interest. It is what makes it worthwhile for people or institutions to lend money. It is calculated as a percentage that is paid at specific times over a period of time. Take a look at how interest works.

Borrowing Money

When you borrow money, you will have a set term to pay it back. Lenders receive interest in addition to the original amount you borrowed. You will always pay back more than you borrowed. For example, if you borrow $10,000 at 10% interest, you will pay back the $10,000 plus an additional $1000 per year. If this is a five-year loan, you could pay back $15,000.

When you borrow money, you need to consider the amount of your loan, the interest rate, and how long the term is. If you have a longer term, your payments will be smaller but you will pay more over the life of the loan. This is something important to keep in mind.

Earning Interest

You earn interest when you keep your money in certain types of accounts or when you loan money out. If you have a savings account or a CD, you might get paid a certain amount of interest each month. The interest will depend on your balance over the month. If you leave the money in the account, you will earn interest on your new balance, including the interest they paid you. Another name for this is compound interest, which is when you earn interest for money you earned as interest.

What Types of Loans Collect Interest?

Most loans will take interest. You might find some offers where you can defer interest payments for six months or a year, but you will generally pay interest on money that you borrow. Installment debt includes your mortgage, car loan, student loans, and others of this type, and the interest costs are a part of your monthly payment. Each month, some of your payment goes to your original loan and some goes to pay the interest.

Revolving debt includes credit cards and other credit accounts. Interest is charged after a certain day in your billing cycle, but if you pay your balance off each month, you won’t have to pay any interest fees.

Final Words

It is important to understand interest and how it is calculated so that you can find the best ways to make a budget that works for you.