What is interest? (easy explanation) –
Introduction 👋
Interest is a confusing word.
We hear it all the time when it comes to borrowing money and bank accounts.
But what actually is interest?
Today we’re going to explain what interest is, in the simplest way possible. ✨
What is interest? 🤷♀️
Interest is a confusing word – part of why it’s so confusing, is that interest can be both GOOD and BAD for your finances.
Disclaimer: This website provides information for guidance and educational purposes only. The Grown-Up School does not provide regulated financial advice. You can seek independent financial advice from a suitably qualified and regulated professional advisor. Check out our disclaimer policy for more information.
To explain “interest” in a simple way –
Interest is basically “extra money to say thank you“
Interest = “extra money to say thank you” 🙏
If you decided to lend a stranger £100 of your hard-won money, would you want them to pay you just £100 back?
OR, would you want them to pay you a little bit extra to say thanks for the loan?
This is what interest is! – Interest is basically “extra money to say thank you for a loan”
Instead of the stranger giving you your £100 back, instead you ask them to pay you £110 back – the £10 is “interest“, to say thank you for the loan.
When you borrow money from a bank, you might have to pay them interest (e.g. £100 in “extra money” to say thank you)
When you add money into your savings account, the bank might pay you interest (e.g. £5 in “extra money” to say thank you!) (Banks “borrow” your savings money off you).
Paying or earning? – Why interest is good AND bad 👍👎
You can either:
- Earn interest from someone when you lend money (yay!🙂), or you can
- Pay interest to someone when you borrow money (nooo!☹️)
This makes interest both a GOOD thing and a BAD thing!
It’s great when you EARN loads of interest from your savings, but bad when you have to PAY loads of interest on a loan.
Hopefully that makes sense!
Interest as a percentage 🤓
To make the word “interest” even more confusing though, interest is usually shown as a percentage (%).
For example, if you borrowed £100 from a bank, they might tell you:
“You have to pay us 10% in interest” or “Our interest rate is 10%”
When it’d be SO much easier to understand if they said:
“If you borrow £100, you will need to pay £10 “extra money” to say thank you. In total you will need to pay us £110.”
This means that if you want to know what you’re paying/earning in real money numbers, you have to either ask the bank, or get your calculator out! ☹️
The way to work out the interest total is:
Interest you need to pay = interest rate x money you’re borrowing
So – if you were borrowing £100 at 10% interest….
10% x £100 = £10
To work this out on a calculator, all you need to do is move the percentage numbers after the decimal point.
For example, 10% is the same as 0.10, 15% is the same as 0.15.
So – to find out 10% of £100 you have to calculate 0.10 x £100. The answer is £10.
It can become quite easy to work interest out the more you practice!
Conclusion 👍
If you’ve made it all the way to the end of this article, well done!
Money can be a tricky subject to learn.
The 3 main things to remember about interest are:
- Interest = extra money to say thank you
- You can earn interest by lending people money, you can also pay interest when you borrow money
- Interest is usually shown as a percentage!
So that’s it! Hopefully you’re feeling more confident about understanding how interest works.
If you know any friends or family members who might benefit from learning about interest, share this post with them!
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