Interests just got interesting

Right from our mathematics textbooks to straight into adulting, there’s no doubt that ‘Interest’ was that one chapter in school with maximum real-life application. So, it’s about time we get interested in knowing about the various kinds of interests that play a significant role in our finances. Here’s to going back-to-basics!

Fact: There are basically only three types of interest that one should know about – simple interest, variable interest, and compounding interest. 

Let’s break this down for you

Say you’re planning to buy a house and have borrowed some money for the same. The lender can be anyone, an individual, a bank or any other financial service. This is called a loan. Now, why should someone give you a lot of money? Either they’re super close to you or they have an agenda. The instances where you borrow from someone with a lending agenda, are the ones where you pay interest. 

To put things into context, interest is a lot like the grease that gets the credit and lending gears going, and is an indispensable part of the way money channels through in the financial sector.

Simple Interest

As the term goes, simple interest is the simplest kind of interest that is there. It is to be paid only once and does not change over time. It is always calculated on the principal at a fixed interest rate for a fixed term. For example, if you borrow Rs. 100 for one year, at an interest rate of 10 percent, after a year you would owe your lender Rs. 110. Here:
– Principal – ₹100,
– Term – one year 
– Rate of interest – 10% 
– Amount to be paid – ₹110

Compound Interest

Compound interest is, however, charged on the principal and on the previously earned interest. For instance, if you borrow Rs.100 at a compound interest rate of 10 per cent for a term of two years, you’ll owe your lender interest of Rs. 10 at the end of the first year and Rs.11 at the end of the second year. Here:
– Principal – ₹100,
– Term – two years 
– Rate of interest – 10% 
– Interest to be paid at the end of 1st year – ₹10
– Interest to be paid at the end of 2nd year – ₹11
– Total amount to be paid at the end of two years – ₹121

Fact: Credit cards and savings accounts usually use compound interest rates in their transactions.

Variable Interest

Variable interest, also known as a floating or adjustable interest is one that does not work with a fixed rate of interest. The interest on the principal gets adjusted based on a reference rate. But, when dealing with floating rates, there’s one question that often pops up – why go for something that is not stable. Well, that’s because in all probability you might get a lower interest rate at some point in time as they keep fluctuating, as opposed to a fixed interest rate.

Here are 5 key tips you should definitely keep in mind while applying for credit or taking a loan:
  • Make sure that the amount of interest paid depends on the terms of the loan that is agreed upon by both parties mutually i.e. the lender and the borrower.
  • Remember, interest is the additional price you pay for taking out a loan. This is the agenda behind helping you out with a loan, in the first place. You now have to pay off the base principal of the loan plus the interest on it.
  • The current banking interest rates often play a key role in determining the interest rates of a loan. So don’t forget to keep an eye on the current rates before opting for a loan.
  • Ensure that you build up a healthy credit score since your interest rate on a credit card, auto loan or another form of interest is largely dependent on it. The higher the score, the better the interest rates.
  • Lastly, while dealing with credit cards make sure you don’t delay your repayments or skip any. Your interest rate might rise in case you delay or just decide to skip one.

So, that’s all for today’s brush up on Interests that were once a chapter in our Math books. Let this sink in, while we come back with more on Interests and the nitty-gritties of it. Don’t forget to keep an eye on this space till then! See ya!

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