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What is Interest?

Interest is the cost you incur for borrowing money from a financial institution. The amount you borrow is the principal amount, on which the interest is calculated, going by the current rates. A bank will usually offer two kinds of interest rates: the simple interest and the compound interest.

Simple interest is charged only once on the principal amount, and may be payable once, or spread out through the payment period; a good example is the typical bank loans. Compound interest, on the other hand, is calculated periodically, for instance, after every twelve months. If you’re going to commit to paying off debt, you should know these four facts about interest rates before you apply for one.

1. Your credit card could work against you

Ever heard of the phrase “credit card debt” or perhaps wondered how you could potentially find yourself in such a predicament? Well, here’s how; suppose you spend $100 with a current rate of 10%. Within one year, your credit card debt will be $110, which will be the principal for calculating the subsequent year’s total debt.

And if you like swiping your credit card at the mall, you might be staring at increasing amounts of thousands of dollars in less than five years. Compound interests are great when they are working for your savings; the same happens, only against you.

Interestingly, many remain ignorant of the power of compound interest, as Albert Einstein calls it, “the greatest force on earth.” Some credit card companies calculate the new principal amount daily; clearly, it’s a costly debt. It’s often wise to read the fine print on your credit card statement so that you get a rough picture of how the bank reaches the totals.

2. High-Interest rates on loans could hurt your savings

High-interest rates resulting from the Federal Reserve’s efforts to tame a high inflation rate triggers a chain reaction of reduced and expensive borrowing, cut spending due to high costs of commodities, expensive mortgage for new home buyers and an income that won’t keep up.

The increasing rates on loans versus the relatively stagnant interest on savings could neutralize any benefits accruing on your savings.

3.  It may be cheaper to borrow now, but expensive to pay back in a few years to come

Banks calculate interest rates on the principal amount, for a given payment period. The bank reserves the right to change these rates periodically, depending on the state of the economy. For the longest time, the economy experiences a slow growth, with a sharp increase in the cost of living.

Rising interest rates may be even higher in the future, and you may have to pay more for the loan you borrow now.

4. Beware of Concession schemes

Banks offer exceptional schemes such as joint or hybrid loans for senior citizens. These loans save upon the interest rates; however, you should approach them with caution, careful to examine the terms and conditions for any special requirements that may be costly.

It’s important for bank lenders to get a grip of how interest rates work, and how debt could be costing you. It’s the best way to avoid unnecessary lending and make your money work for you.