A charge paid for borrowing money. Interest is usually expressed as a percentage of the amount borrowed or interest rate.
Interest is basically the cost of borrowing money. Lenders and creditors make money off the interest charged when a borrower or client gets a loan or line of credit. Sometimes, lenders and credit card companies increase interest rates to offset the risk of doing business with people who have low credit scores.
There are different kinds of interest that you should know about so you understand what you are paying for when you make a payment to a lender or creditor.
Simple interest is a one-time charge. So if you pay 10 percent simple interest annually on $500, you will pay $50 in interest a year.
Compounding interest is generally more common for loans and lines of credit and more costly. Compound interest is charged repeatedly depending on the terms of the contract. That means you could be paying interest daily, weekly or monthly. Many credit card companies and lenders choose to charge interest every month. You can figure out the monthly rate by dividing the annual interest rate (APR) by 12.
Remember that compound interest and simple interest mean different things for your finances. If you had a $1,000 loan at 12 percent annual interest and you planned to pay it back all at once, you’d pay $120 in finance charges. If the interest was compounded each month rather than annually, your finance charges would $126.83.
Also keep in mind what interest means for your finances if you don’t pay off your balance each month. If you keep using your credit card while you are paying off your balance, the minimum payment may not even cover interest. This puts you at risk for increasing your debt, rather than decreasing it. If you can’t pay off your entire balance each month, make a commitment to yourself to make more than the minimum payment and keep your credit card out of reach. That way you can pay down your debt and avoid paying interest on interest.
July 8, 2006
