## What is Interest?

Firstly, interest is the amount of money a lender or financial institution (most commonly a bank) charges for lending people money through loans. It is usually expressed as a percentage of the amount loaned to an individual over a period of time and is the main way in which financial institutions accrue money from borrowers.

So let’s say you take out a loan of $600,000 to purchase your first home, and your bank has an annual fixed interest rate of 4%. Your bank will then receive $240,000 in interest on top of the principal amount. This is for traders who are borrowing and lending money: it means there’s interest to be made when investing your money!

Secondly, interest refers to the amount of shares an investor holds within a particular company, and which is also expressed as a percentage. We’ve talked before about how when you buy a stock, you own a percentage of the company. So if you purchase one **stock** from a company which holds 1,000 stocks, you own 0.1% of the company. This percentage is also referred to as interest.

**KEY TAKEAWAYS**

- Interest is the amount of money a lender or financial institution charges for lending people money through loans
- It's expressed as a percentage of the amount loaned to an individual over a period of time
- It also refers to the amount of shares an investor holds within a particular company, and which is also expressed as a percentage
- There are 2 main types of interest to know about: Simple and compounding

## 2 Types of Interest

There are two **types of interest** that are applied to loans: simple interest and **compound interest.**

### What is simple interest?

**Simple interest** is a set rate charged on the initial amount of money borrowed. So if you borrow $10,000 to buy a new car and the bank charges a 4% simple interest rate, you’ll pay a fixed interest rate of $400 on top of the principle $10,000 – so $10,400 in total.

### What is compound interest?

**Compound interest** is interest on both the principal and the accumulating interest paid on that loan. Compound interest is great when it comes to investing, as it allows your money to grow over a long period of time.

If you invest $1,000 tomorrow, then $1,000 in a year, and you continue doing that for 30 years with an interest rate of 8%, in 30 years time you could have a pot of $113,283. That’s $83,283 earned in interest!

Compound interest is one way to beat **inflation****.**

**Difference Between Simple and Compound Interest**

In a nutshell, the **difference between simple interest and compound interest** is that when calculating simple interest, you don't add the interest of previous years into the calculation of the new interest amount.