- 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.