What is Interest Anyways?

Now’s the time to start getting interested about interest! But what is interest exactly? From impacting everyday purchases to shaping global economic trends, interest rates play a pivotal role in shaping our financial landscape. Let's explore answers to a few common questions regarding the topic.

What is interest?

Interest is the cost associated with borrowing funds. When you're the borrower, you pay interest and when you're the lender, you earn it.

Is interest bad?

Now that we can answer the question, "What is interest?", you're probably wondering, is it bad? Interest rates usually get a negative connotation, especially over the last several years. You’ve probably heard economists and other financial professionals talk about rising rate environments and how that can impact consumers. Obviously, high rates can impact your personal finances, but have you ever stopped to think about how they can help you? You can actually benefit from a good interest rate, which brings us to APR vs. APY.

What’s the difference between APR vs APY?

Annual percentage yield (APY) refers to the interest that you earn on a savings product, such as a savings certificate or money market. In this scenario, you’re lending the money to them and earning a percentage over time, ultimately benefiting you and your wallet. On the other hand, annual percentage rate (APR) is the interest you accrue from borrowing money for solutions, such as your credit card. In this scenario, you’re being charged for borrowing in addition to the loan’s principal.

Another way to look at APR and APY is that they’re the cost of doing business with a financial institution or lender.

What’s the difference between simple vs. compound interest?

Investopedia defines simple interest as “the annual percentage of a loan amount that must be paid to the lender in addition to the principal amount of the loan. The total dollar amount is determined by the length of time it takes for the loan to be repaid.” This type of interest is typically used in situations where the time period is relatively short, or when the rate remains constant throughout the duration of the investment or loan.

Compound interest, on the other hand, can be a little more complicated. It takes into account the interest earned on both the initial principal and any accumulated from previous periods. Typically, these compound periods are either daily, monthly, quarterly, semiannually, or even annually. Depending on whether your investing or borrowing, compound rates can have a dramatic impact on how much you’re earning or ultimately going to be paying.

For example, if you’re investing money in a savings solution that has a compounding rate, your funds will grow faster than if it had a simple one. Want to the calculate what you’re earning on your savings? Check out our easy to use Benefits of Compounding calculator.

While we’ve covered the answers to questions like "What is interest?" and other related topics, you may be interested in learning more. Check out this Money Monday video for more interesting insight!