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  • What is Interest and How Does it Work?

    2019-06-07T16:18:02-05:00By |Personal Finance|

    You’ve almost certainly dealt with interest whether you’ve paid it or earned it, but do you really understand it?

    Simply put, interest is the price that’s paid for using someone else’s money. If you’re the borrower, you’ll pay interest, but if you’re the lender, you’ll earn interest.

    It seems simple, but interest comes in different forms, so we’ll explain it all below.

    Paying Interest When You Take Out a Loan

    When you borrow money, you pay for that privilege. You have to pay back the money you borrow, and then you’ll have to pay additional money in the form of interest.

    This interest is calculated as a percentage of the loan’s balance, and it’s paid to the lender periodically. It’s usually quoted as an annual rate but it can be calculated for any period of time.

    There are different types of debt, and sometimes the interest isn’t obvious, because it’s not always listed separately from the rest of the debt.

    Installment debt: When you buy something like a house or car, or take out a student loan, your interest costs are part of your monthly payment. Every month, part of your payment goes toward the reduction of your debt, while another portion is the cost of the interest.

    At the beginning of your loan, you’ll pay more in interest, but the total amount you pay each month will remain the same. As the amount of debt decreases, the interest owed will decrease, and more money will go toward paying off the actual debt. These loans are paid off over a specific time period.

    Revolving debt: Credit cards are an example of revolving debt because you can borrow more each month and pay it periodically. With credit cards, you can keep spending money as long as you stay beneath your credit limit. Interest on credit cards is calculated daily, and as your balance climbs, so will your interest payment.

    Other costs associated with interest: The APR, or annual percentage rate, of a loan, is how much you pay per year in interest. When you borrow, the lower the APR, the better.

    Earning Interest When You Open an Account

    When you deposit money, you are the one earning interest, as long as your money is in an interest-bearing account or certificate. This is because financial institutions use your money to fund loans to other customers, and part of the money they make comes back to you as interest.

    When you look at your statements, you’ll see that your account balance increases periodically, and an interest payment will be noted as a transaction. If you can leave the interest in the account, you’ll be able to build not only on your initial deposit but also on that interest.

    What’s more, most financial institutions compound interest, which works in your favor. Because the interest is calculated along the way and added to your balance, you earn more from compounded interest than you would from simple interest.

    At Connexus, interest is a big deal because we offer low rates on loans and higher yields on deposits. That means when you choose Connexus over a big bank, you’ll pay less interest on your loans and earn more on your deposits.

    Want More Financial Insights?

    Check out more of the expert articles in our Connexus Blog.

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